as base and return above such zero risk security will be taken as base to expect returns on
the risk oriented securities. This will decide the desired level of beta.
The risk in bond is that of change in interest. If one holds bond upto its duration, the
interest rate risk will be equal to zero. The investor needs cash at different points of time.
This will influence duration of the holding period. Therefore in portfolio management an
investor needs to list out the cash needs at various points of time. This will have effect
on the cash inflows and cash outflows, sales and purchases of securities in a port folio.
An investor expects higher returns for larger duration.
Now we know that the duration and beta has got its effect on holding of different kinds of
assets and with what duration in a portfolio. It must also be noted that not only the
proportion of each class of assets will be get affected, but also composition of the
portfolios within each asset class will also be get affected.
The expected rate of return on the total portfolio will be influenced by the asset allocation
i.e., bonds, equity and money market instruments. Once we decide to take the risk, the
level of risk in the form of beta is the target beta. Beta is a vulnerability of return on
security with reference to changes in market returns.
Even after the determination of a target beta with duration, changes in market values with
higher velocity may alter the weights and averages of a security/s which may necessities
a rebalancing of portfolio.
An investor must necessarily be ready against the slump or boom in the market values.
Anticipating in advance, that is the market movements and exploiting it in the short run,
is a skill rather than luck. To make quick realignments in beta and duration,
diversification shall be made to such an extent in a portfolio, preferably with adjustable
liquidity. We must keep out portfolio beta in and around the target value to make quick
adjustments, so that we can adopt defensive or an offensive portfolio. Defensive implies
protection against slump. Offensive implies taking advantage of a rising market. To
switch over this way or that way, an investor must have a clear plan - whether to sell or
purchase, how much, in what duration, in which class etc. A pre-determined plan with
lot of options will enable an investor to run an investment in proper gear. This is often
called as tactical asset allocation.
Portfolio design depends upon the following points:
- Selection of industries
- Selection of firms in an industry
- Selection of Assets Class
- Selection of security under each of Asset Class
- Estimation of return and risk on each security