Portfolio Management using Linear Programming

Abhinav Sharma (119278003) Keerthi Kalyan Kembasaram (119278027) Dinesh Babu (11928044) Aditya Gaddam (11928059) Hridyesh Bohra (119278061) Sriram Bhattaru (119278065) Manu AR (119278074)

Portfolio Management
Evaluation of individual returns and risks of investments Contribution to overall portfolio to manage the risk and return of a portfolio Risk and return on investment are always proportional to each other Task is to allocate the total investment of an individual to different asset classes in order to maximize the return and minimize the risk of the portfolio.
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Markowitz Model
Henry Markowitz provided a framework for measuring the risk reduction benefits of diversification The model uses the standard deviation of returns as the measure of investments risk How combining risky securities into a portfolio affected the risk and return of a portfolio Unless the returns of the risky assets are perfectly correlated, risk is reduced by diversifying across assets Using linear programming we can easily identify the weights to be allocated for different assets in a portfolio to meet the target objectives of risk and return
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Our Problem Statement

To find out the weights to be allocated to each of the stocks for a given investment of Rs 100,000 and for different market risk factors and weight constraints.

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Calculations
Expected return on a portfolio over risk free rate of return is equal to the market risk factor(beta) multiplied by the market premium.
E(Rp) = Expected returns on portfolio Rf = Risk free rate of return- It is the rate of return on an Investment with zero market risk. The returns on treasury bills issued by US treasury are considered generally to be risk free and the rate of return on T-bills is considered to be risk free rate of return. Rm = Return on market- It is the average rate of return on all the securities present in the market. For the above problem it is taken as the average return of all the stock trading on BSE index. = market risk factor- This is a factor which denotes the sensitivity of the stock returns to the average market returns. s for the stocks mentioned in the problem have been taken from BSE website.
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E(Rp) = Rf + (Rm - Rf)

Objective Function and Constraints

w1, w2, w3, w4, w5 are the weights of investment 1, 2, 3, 4, 5 are the average industrial market risk factors for the stocks of HDFC, L&T, E-Bay, IBM, Airtel respectively. Total market risk factor of the portfolio p=w1*1+w2*2+w3*3+w4*4+w5*5 The objective function of the investment is to have an overall portfolio market risk (p) at 1.5 The constraints of investment are as follows. The investor cannot allocate more than 40% and less than 10% in any of the individual stocks. 0.1 <= (w1,w2,w3,w4,w5) <= 0.4 The weights of different stock in the portfolio have to be found out according to the given constraints and objective function.
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BSE Data: Returns on Stock

BSE500 Month(2011) OpenPrice Close Price Dividends distributed($) Return(%) For Calculation

Jan
Feb March April May June July Aug Sep

7,989.28
6,888.55 7,440.05 7,449.52 7,240.14 7,240.14 7,296.61 7,148.11 6,559.20

7,128.29
6,850.40 7,437.26 7,427.14 7,233.85 7,265.32 7,111.31 6,487.22 6,385.76

500.00
634.00 789.00 678.00 876.00 567.00 1,000.00 1,200.00 2,500.00
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-4.5184297
8.649861 10.5672677 8.80083549 12.0123368 8.17912361 11.165459 7.54199362 35.4701793

0.954815703
1.08649861 1.105672677 1.088008355 1.120123368 1.081791236 1.11165459 1.075419936 1.354701793
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Data: Stock Beta Values

Stock
HDFC bank (Banking Industry) L&T infrastructure (Engineering Construction) Beta (industrial Average) 0.75 1.65

E-Bay (E- Commerce)

IBM (IT- Services) Airtel (Telcom)
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1.14
1.10 1.01
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Other Market Data

Overall market return on BSE(500) index

Rm= 10.87%
Return on Treasury bills

Rf= 4.6%
This is the risk free rate of return

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Solution for = 1.20

Stock HDFC bank(Banking Industry) L&T infrastructure(Engineering Construction) E-Bay(E- Commerce) IBM(IT- Services) Airtel(Telcom) Total Amount 9,999.90 23,311.32 39,849.41 16,671.20 10,168.18 100,000.00 Commission 25.00 25.00 25.00 25.00 25.00 125.00 Weight 10.00% 23.31% 39.85% 16.67% 10.17% 100.00% Beta (industrial Average) 0.75 1.65 1.14 1.10 1.01 1.20

Target Beta

1.20

Maximum Amount available for investment(Rs.) Constraint1 Constraint2 Constraint3

100000 1.20 Beta value 100.00% 0.1 <= weight 1.20 100.00% <=0.4
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Solution for = 1.19

Stock Amount Commission Weight Beta(industrial Average)

HDFC bank(Banking Industry) L&T infrastructure(Engineering Construction) E-Bay(E- Commerce) IBM(IT- Services) Airtel(Telcom) Total Target Beta Maximum Amount available for investment(Rs.) Constraint1 Constraint2 Constraint3

11,066.47 22,323.00 39,421.13 16,286.85 10,902.54 100,000.00 1.19

25.00 25.00 25.00 25.00 25.00 125.00

11.07% 22.32% 39.42% 16.29% 10.90% 100.00%

0.75 1.65 1.14 1.10 1.01 1.19

100000 1.19 Beta value 100.00% 0.1 <=

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1.19 100.00%

weight

<=0.4
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Solution for = 1.18

Stock HDFC bank(Banking Industry) L&T infrastructure(Engineering Construction) E-Bay(E- Commerce) IBM(IT- Services) Airtel(Telcom) Amount 12,715.33 21,541.96 39,082.69 15,983.12 10,676.91 Commission 25.00 25.00 25.00 25.00 25.00 Weight 12.72% 21.54% 39.08% 15.98% 10.68% Beta(industrial Average) 0.75 1.65 1.14 1.10 1.01

Total Target Beta

Maximum Amount available for investment(Rs.) Constraint1

100,000.00 1.18
100000

125.00

100.00%

1.18

1.18 Beta value

1.18

Constraint2 Constraint3

100.00% 0.1 <=

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100.00% weight <=0.4

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Solution for = 1.17

Stock HDFC bank(Banking Industry) L&T infrastructure(Engineering Construction) E-Bay(E- Commerce) IBM(IT- Services) Airtel(Telcom) Amount 14,364.51 20,760.77 38,744.17 15,679.32 10,451.23 Commission 25.00 25.00 25.00 25.00 25.00 Weight 14.36% 20.76% 38.74% 15.68% 10.45% Beta(industrial Average) 0.75 1.65 1.14 1.10 1.01

Total Target Beta Maximum Amount available for investment(Rs.) Constraint1

100,000.00 1.17 100000

125.00

100.00%

1.17

1.17 Beta value

1.17

Constraint2 Constraint3

100.00% 0.1 <=

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100.00% weight <=0.4

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Solution for = 1.16

Stock HDFC bank(Banking Industry) L&T infrastructure(Engineering Construction) E-Bay(E- Commerce) IBM(IT- Services) Airtel(Telcom) Amount 16,013.53 19,979.66 38,405.69 15,375.55 10,225.58 Commission 25.00 25.00 25.00 25.00 25.00 Weight 16.01% 19.98% 38.41% 15.38% 10.23%

Beta(industrial Average)
0.75 1.65 1.14 1.10 1.01

Total Target Beta Maximum Amount available for investment(Rs.)

100,000.00 1.16 100000

125.00

100.00%

1.16

Constraint1

1.16 Beta value

1.16

Constraint2 Constraint3

100.00% 0.1 <=

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100.00% weight <=0.4

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Solution for = 1.15

Stock Amount Commission Weight Beta(industrial Average)

HDFC bank(Banking Industry) L&T infrastructure(Engineering Construction) E-Bay(E- Commerce) IBM(IT- Services) Airtel(Telcom)

17,662.71 19,198.46 38,067.17 15,071.75 9,999.90

25.00 25.00 25.00 25.00 25.00

17.66% 19.20% 38.07% 15.07% 10.00%

0.75 1.65 1.14 1.10 1.01

Total Target Beta

100,000.00 1.15

125.00

100.00%

1.15

Maximum Amount available for investment(Rs.)

Constraint1

100000
1.15 1.15

Constraint2 Constraint3

100.00% 0.1 <=

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100.00% weight <=0.4

15

Treynors Index
It is the excess of portfolio return over riskfree rate of return per unit of systematic risk Treynors Index=(Rp - Rf )/

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Treynors Index for different values of Beta

Beta 1.15 1.16 1.17 1.18 Treynors index 9.09 8.92 8.76 8.58

1.19
1.20
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8.42
8.27
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Portfolio Distribution
Beta HDFC L&T 0.192 0.1998 E BAY 0.3807 0.3841 IBM 0.1507 0.1538 AIRTEL 0.1 0.1023

1.15 1.16 1.17 1.18 1.19

0.1766 0.1601

0.1436
0.1272 0.1107 0.1

0.2076
0.2154 0.2232 0.2331

0.3874
0.3908 0.3942 0.3985

0.1568
0.1598 0.1629 0.1667

0.1045
0.1068 0.109 0.1017
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1.2

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Portfolio Distribution Plot

0.45 0.4 0.35 Weights

0.3
0.25 0.2 0.15 0.1 0.05 0

HDFC
L&T E BAY IBM AIRTEL

1.15

1.16

1.17

1.18

1.19

1.2

Beta
19

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Expected Return vs Beta

Expected Return
12.15 12.1 12.05 12 11.95 11.9 11.85

Expected Return

11.8
11.75 11.7 11.65 1.15 1.16 1.17 1.18 1.19 1.2

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Questions?

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