Portfolio Analysis

The purpose of this project is to introduce you to construction (building) a portfolio and then optimizing it with respect to some investment goal. For this particular project you will simply optimize the portfolio for minimum risk for a given return and rebalance the portfolio at least twice. You will then assess the performance of your portfolio with various performance metrics that you have learned during this course. Assume that you are advising some client about how best to invest his money over a long investment horizon and therefore do not resort to short-term trading strategies or highly leveraged positions using options. Your report should follow the following outline.

Describe the theory behind construction of portfolios, why do you hold stocks in portfolios, what are the risk/return characteristics of stocks (i.e. stand-alone risk, market risk) and portfolios and how do they differ. What are the key characteristics of stocks that affect the risk of portfolios (i.e. correlation etc)? How do you construct optimal risky portfolios? What is the efficient frontier, how do you choose an optimal portfolio (i.e. tangent to indifference curve). What happens when you introduce a risk free asset? What is the CAL and how does the risk free asset influence your choice of an optimal portfolio i.e. earlier when you had only risky assets you identified the efficient frontier and chose a tangent portfolio according to your indifference curve. But now you choose to allocate your capital between this portfolio and the risk free asset. However, you can do better by abandoning your preferred risky portfolio and choosing the tangent portfolio that is at tangency point of the CAL and the efficient frontier. This new CAL is unique; it is called the CML. Your earlier choice was the tangent between your indifference curve and the efficient frontier. Now your choice of a risky portfolio is the tangent portfolio but this tangent is between the efficient frontier and the CML

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