Portfolio (finance) Totally Explained

Everything about Portfolio Finance totally explained

In finance, a portfolio is an appropriate mix of or collection of investments held by an institution or a private individual. In building up an investment portfolio a financial institution will typically conduct its own investment analysis, whilst a private individual may make use of the services of a financial advisor or a financial institution which offers portfolio management services. Holding a portfolio is part of an investment and risk-limiting strategy called diversification. By owning several assets, certain types of risk (in particular specific risk) can be reduced. The assets in the portfolio could include stocks, bonds, options, warrants, gold certificates, real estate, futures contracts, production facilities, or any other item that's expected to retain its value.

Management

Portfolio management involves deciding what assets to include in the portfolio, given the goals of the portfolio owner and changing economic conditions. Selection involves deciding what assets to purchase, how many to purchase, when to purchase them, and what assets to divest. These decisions always involve some sort of performance measurement, most typically expected return on the portfolio, and the risk associated with this return (for example the standard deviation of the return). Typically the expected return from portfolios of different asset bundles are compared.
The unique goals and circumstances of the investor must also be considered. Some investors are more risk averse than others.
Mutual fund have developed particular techniques to optimize their portfolio holdings. See fund management for details.

Porfolio formation

Many strategies have been developed to form a portfolio.

equally-weighted portfolio
capitalization-weighted portfolio
price-weighted portfolio
optimal portfolio (for which the Sharpe ratio is highest)

Models

Some of the financial models used in the process of Valuation, stock selection, and management of portfolios include:

Maximizing return, given an acceptable level of risk.

Modern portfolio theory—a model proposed by Harry Markowitz among others.

The single-index model of portfolio variance.

Capital asset pricing model.

Arbitrage pricing theory.

The Jensen Index.

The Treynor Index.

The Sharpe Diagonal (or Index) model.

Value at risk model.

Returns

Portfolio returns can be calculated either in absolute manner or in relative manner. Absolute return calculation is very straight forward, where return is calculated by considering total investment and total final value. Time duration and cash flow in portfolio doesn't influence final return. To calculate more accurate return of your investments you've to use complicated statistical models like Internal rate of return or Modified Internal Rate of Return. The only problem with these models are that, they're very complicated and very difficult to compute by pen and paper. You need to have a scientific calculator or some software. Both of these models consider all cash flow(Money In/Money Out) and provide more accurate returns than absolute return. Time is a major factor in these models.

Further Information

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