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Neha Khosla, Lovely Professional University Unit 12: Models

Unit 12: Models Notes

CONTENTS
Objectives
Introduction

12.1 Markowitz Risk-return Optimisation
12.2 Single Index Model
12.3 Two Factor Model

12.4 Multi Factor Model
12.5 Summary
12.6 Keywords
12.7 Self Assessment
12.8 Review Questions

12.9 Further Readings

Objectives

After studying this unit, you will be able to:
Discuss Markowitz Risk-return Optimisation

Explain Single Index Model
Describe Two Factor Model
Understand Multi Factor Models

Introduction

The optimal portfolio concept falls under the modern portfolio theory. The theory assumes
(among other things) that investors fanatically try to minimize risk while striving for the highest
return possible. The theory states that investors will act rationally, always making decisions
aimed at maximizing their return for their acceptable level of risk.
Harry Markowitz used the optimal portfolio in 1952, and it shows us that it is possible for
different portfolios to have varying levels of risk and return. Each investor must decide how
much risk they can handle and then allocate (or diversify) their portfolio according to this
decision.
Suppose you find a great investment opportunity, but you lack the cash to take advantage of it.
This is the classic problem of financing. The short answer is that you borrow either privately
from a bank, or publicly by issuing securities. Securities are nothing more than promises of
future payment. They are initially issued through financial intermediaries such as investment
banks, which underwrite the offering and work to sell the securities to the public. Once they are
sold, securities can often be re-sold. There is a secondary market for many corporate securities.
If they meet certain regulatory requirements, they may be traded through brokers on the stock
exchanges, such as the NYSE, the AMEX and NASDAQ, or on options exchanges and bond
trading desks.

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