### Investment Portfolio Project

Investment Portfolio Project

University of Phoenix

Introduction needs to go here

| | |5 Yr Average |

| | |Return |

|T-bond |25% |0.02 |

|Microsoft |20% |-0.33 |

|Time Warner |10% |0.11 |

|Disney |20% |0.02 |

|Motorola |10% |-0.05 |

|Home Depot |15% |-0.02 |

| | | |

|Average Return |-0.042 |

|Risk Free | |-1.72 |

| | | |

| | |-1.76 |

|STDEV | |0.15 |

| | | |

|Sharpe | |-11.65 |

| | | |

| | |5 Yr Average | | | |betas |

| | |Return | | | | |

|T-bond |25% |0.02 | | |Microsoft |1 |

|Microsoft |20% |-0.33 | | |Time Warner |1.37 |

|Time Warner |10% |0.11 | | |Disney |0.96 |

|Disney |20% |0.02 | | |Motorola |1.81 |

|Motorola |10% |-0.05 | | |Home Depot |0.5 |

|Home Depot |15% |-0.02 | | | | |

| | | | |Average Beta |1.128 |

|Average Return |-0.042 | | | | |

|Risk Free | |-1.72 | | | | |

| | | | | | | |

| | |-1.76 | | | | |

|Beta | |1.128 | | | | |

| | | | | | | |

|Treynor | |-1.56 | | | | |

| | | |

| | | |

| | |5 Yr Average | | | |betas |

| | |Return | | | | |

|T-bond |25% |0.02 | | |Microsoft |1 |

|Microsoft |20% |-0.33 | | |Time Warner |1.37 |

|Time Warner |10% |0.11 | | |Disney |0.96 |

|Disney |20% |0.02 | | |Motorola |1.81 |

|Motorola |10% |-0.05 | | |Home Depot |0.5 |

|Home Depot |15% |-0.02 | | | | |

| | | | |Average Beta |1.128 |

|Average Return |-0.04167 | | | | |

| | | | | | | |

| | | | | | | |

|Risk Free | |-0.0172 | | | | |

|Market Return |-0.0445 | | | | |

| | | | | | | |

| | |-0.0617 | | | | |

|Beta |x |1.128 | | | | |

| | | | | | | |

| | |-0.0696 | | | | |

| | |0.187 | | | | |

| | | | | | | |

|Jensen | |0.117403 | | | | |

There are three familiar ratios that measure a portfolio’s risk-return tradeoff: Sharpe’s ratio, Treynor’s ratio, and Jensen’s Alpha. The Sharpe ratio, developed by William F. Sharpe, is the ratio of a portfolio’s total return minus the risk-free rate divided by the standard deviation of the portfolio, which is a measure of its risk. The Sharpe ratio is simply the risk premium per unit of risk, which is quantified by the standard deviation of the portfolio. The risk-free rate is subtracted from the portfolio return because a risk-free asset, often exemplified by the T-bill, has no risk premium since the return of a risk-free asset is certain. Therefore, if a portfolio’s return is equal to or less than the risk-free rate, then it makes no sense to invest in the risky assets. for this reason, the Sharpe ratio is a measure of the performance of the portfolio compared to the risk taken—the higher the Sharpe ratio, the better the performance and the greater the profits for taking on additional risk. While the Sharpe ratio measures the risk premium of the portfolio over the portfolio risk, or its standard deviation, Treynor’s ratio, popularized by Jack L. Treynor, compares the portfolio risk premium to the diversifiable risk of the portfolio as measured by its beta.

Alpha is a coefficient that is proportional to the excess return of a portfolio over its required return, or its expected return, for its expected risk as measured by its beta. Hence, alpha is determined by the fundamental values of the company in contrast to beta, which measures the return due to its volatility. Jensen’s alpha, developed by Michael C. Jensen, uses the capital asset pricing model (CAPM) to determine the amount of the return that is firm-specific over that which is due to market risk, which causes market volatility as measured by the firm’s beta. Jensen’s alpha can be positive, negative, or zero. Note that, by definition, Jensen’s alpha of the market is zero. If the alpha is negative, then the portfolio is underperforming the market.

The Sharpe ratio is essential in determining if the success of the portfolio is based on the effective and precise decisions made by the portfolio manager or the success is merely associated with a high level of risk taken. The Sharpe ratio can provide information to help investors to construct portfolios to obtain the maximum rate of return with the lowest possible level of risk. Treynor Index is another effective and powerful performance measurement method. The objective of the Treynor index is to determine the excess of return from investment units, taking into consideration systematic risk. This method helps investors to analyze how different structures of the portfolio can affect the returns of the investment. The difference between the Treynor Index and the Sharpe ratio is that the first method includes beta information.

The portfolio performance was consistent with the performance of the market index S&P. Some stocks, including Home Depot and Disney outperform S&P. Motorola had the lowest performance of the portfolio. Microsoft and Time Warner were significantly close to S&P. The fluctuations of the stock price of the portfolio were constantly similar to the fluctuations of S&P. S&P slightly outperformed the constructed portfolio. However, if Motorola and Time Warner are replaced with different asset classes, the constructed portfolio’s performance would exceed S&P’s performance.

Previously when team c constructed the portfolio our recommendations were to equally distribute the weights of the securities in the portfolio. With the securities evenly distributed it was discovered that the portfolio had a 3% weighted average risks on returns. After modifying the weights the portfolio’s average risk on return was lowered to just 2%. The portfolio’s 5 year expected return is not necessarily an ideal situation. With an expected return in the negatives, the team must look at the securities and adjust our choices. According to the Sharpe ratio that we have calculated our portfolio has a large amount of risk compared to the potential return. The Sharpe ratio indicates the reward per unit of risk; therefore it is wise to choose a portfolio with a high Sharpe ratio to maximize returns per unit of risk. A ratio in the 30-40% range would say that the portfolio has low risks with average returns. Our current ratio of -11.65 shows high risk with low returns. Revisiting the weights and making adjustments can help team c raise our Sharpe ratio giving us a more favorable outcome.

Although our ratios in all three indices were not ideal, most of our portfolio’s choices were favorable when compared to their industry competitors. Due to the current economic conditions choosing to eliminate our stock choice in Home Depot may be a necessary option while picking up a stock in an entirely different industry to help balance out some losses we may incur due to the declining stock. Changing our Microsoft choice for a competitor such as Oracle can also help team c increase our return while possibly lowering our risk over the next 5 years since Oracle’s projected growth, sales and numbers are generally higher than that of Microsoft.

Conclusion

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