1. PORTFOLIO CONSTRUCTION
PORTFOLIO IS A COMBINATION OF
SECURITIES SUCH AS STOCKS, BONDS AND
MONEY MARKET INSTRUMENTS
THE PROCESS OF BLENDING TOGETHER THE
BROAD ASSET CLASSES SO AS TO OBTAIN
OPTIMUM RETURN WITH MINIMUM RISK IS
CALLED PORTFOLIO CONSTRUCTION
APPROACHES IN PORTFOLIO CONSTRUCTION
1. TRADITIONAL APPROACH
2. MARKOWITZ APPROACH
TRADITIONAL APPROACH

2. 1. ANALYSIS OF CONSTRAINTS
A. INCOME NEEDS
B. LIQUIDITY
C. SAFETY OF PRINCIPAL
D. TIME HORIZON
E.TAX CONSIDERATION
F. TEMPERAMENT
2. DETERMINATION OF OBJECTIVES
A. CURRENT INCOME
B. GROWTH IN INCOME
C. CAPITAL APPRECIATION
D. PRESERVATION OF CAPITAL
3. SELECTION OF PORTFOLIO
A. CURRENT INCOME AND ASSET MIX
B. GROWTH OF INCOME AND ASSET MIX
C. CAPITAL APPRECIATION AND ASSET MIX
D. SAFETY OF PRINCIPAL AND ASSET MIX
4. RISK AND RETURN ANALYSIS

3. 5. DIVERSIFICATION
SIMPLE DIVERSIFICATION
PORTFOLIO RISK CAN BE REDUCED BY
SIMPLEST KIND OF DIVERSIFICATION
THE NAÏVE KIND OF DIVERSIFICATION IS
KNOWN AS SIMPLE DIVERSIFICATION
IN SIMPLE DIVERSIFICATION SECURITIES
ARE SELECTED RANDOMLY AND NO
ANALYTICAL PROCEDURE IS USED.
TOTAL RISK OF ANY PORTFOLIO CONSISTS
OF SYSTEMATIC RISK AND UNSYSTEMATIC
RISK AND THIS TOTAL RISK IS MEASURED BY
VARIANCE OF RETURNS OVER TIME.

4. MANY STUDIES SHOW THAT SYSTEMATIC
RISK COMPRISES OF ONE QUARTER OF
TOTAL RISK
THE SIMPLE RANDOM DIVERSIFICATION
REDUCES THE UNSYSTAEMATIC RISK BUT IT
FAILS TO REDUCE THE SYSTEMATIC RISK.
PROBLEMS OF VAST DIVERIFICATION
PURCHASE OF POOR PERFORMERS
INFORMATION ADEQUACY
HIGH RESEARCH COST
HIGH TRANSACTION COST
MARKOWITZ MODEL
BASED ON MINIMISING PORTFOLIO RISK BY
TAKING LIMITED NO OF SECURITIES OR BY

5. TAKING TWO SECURITIES OF NEGATIVE
CORRELATION.
ASSUMPTIONS:
THE INDIVIDUAL INVESTOR ESTIMATES RISK
ON THE BASIS OF VARIABILITY OF RETURNS
I.E VARIANCE OF RETURNS
FOR A GIVEN LEVEL OF RISK, INVESTOR
PREFERS HIGHER RETURN TO LOWER
RETURN. LIKEWISE FOR A GIVEN LEVEL OF
RETURNS INVESTOR PREFERS LOW RISK
THAN HIGH RISK.
FINDINGS:
PORTFOLIO RISK IS NIL IF THE SECURITIES
ARE RELATED NEGATIVELY

6. RISK CAN BE ELIMINATED IF THE SECURITIES
ARE PERFECTLY NEGATIVELY CORRELATED
THE STANDARD DEVIATION OR RISK OF
PORTFOLIO IS SENSITIVE TO
1. THE PROPORTION OF FUNDS DEVOTED
TO EACH STOCK
2. THE STANDARD DEVIATION OF EACH
SECURITY
3. COVARIANCE BETWEEN TWO STOCKS.