Investment and Portfolio Management for Pricing - myassignmenthelp

Question: Discuss about theInvestment and Portfolio Management for Asset Pricing. Answer: Asset Pricing Model Asset pricing model is theoretically a model that is used to determine the accurate expected or estimated return rate of an asset in order to implement decisions linked with the addition of assets so that it can be displayed in a diversified portfolio. Essentially the model aims at determining the sensitivity of the particular asset in respect to a market risk. The asset pricing model is applied by the investors in order to verify and ultimately choose a set of securities that will add to the rate of return and finally result in a higher rate of portfolio return, keeping in mind the optimum level of risk. The Capital Asset Pricing Model is one of the most acclaimed methods which are largely used by investors in order to determine and select a well diversified portfolio. The two major variables included in the selection of portfolio management is the desired risk involved and the expected rate of return that is assumed after keeping the risk in mind. There are a lot of applications of the Capital Asset Pricing Model. The first application is where the CAPM is used to define the risk premium of an asset which is observed as a contribution by risk related to the total assets in the portfolio of the investors. The next application lies in the fact that the CAPM is used to get a more real or true rate of return rather than selecting an investmen t on the basis of estimated rate of return. The most effective application of CAPM lies in the method where the beta coefficient is calculated using the regression analysis. The validity of the CAPM model is based on arguable terms. This means that some experts are of the view that the beta coefficient though does properly assess the rate of return but it is not the only determinant of the expected returns. The other experts also noted that the beta if not measured properly will definitely lead to errors. But in spite of all these limitations CAPM is used worldwide by investors (Dempsey 2013). For instance when a choice is provided between two investments, the one with the higher beta coefficient has to be selected. Bonds -sensitivity to interest rate changes Bonds are essentially financial statements that are used in order to obtain a continuous inflow of cash payments in the form of interest at regular intervals. Risk related to the payment of interests related to a bond is the factor that affects the price of bonds. Bonds are highly sensitive to the change in interest rates. The yield or discount rate that is attached with a particular bond when increases, the price of the bond decreases and when the yield decreases the price increases. Thus when the interest rates fluctuate in the market, the yield or discount rates of the bonds increase therefore the price of the bonds decrease. The fluctuations in short-term interest rates will definitely affect different types of bonds with different maturity terms. In times of inflation a particular firm may increase the yield of a particular bond in order to retain its investors but in the process the price of the bond will surely decrease. The weaknesses related to the bonds are the credit risk and fluctuation in the rate of interest risk. The fluctuation in the rate of interest risk is the primary weakness as described above and secondly the credit risk is the risk that is associated with risk of default. Therefore these are the two weaknesses associated with bonds (Woodford 2012). Portfolio performance The performances of the portfolio of an investor depend not only upon the estimated rate of return but also on the percentage of desired risk that is involved in the particular investment. In order to measure the effectiveness of the portfolio there are three measures namely the Treynor Measure, Sharpe ratio and Jensen measure. Treynor measure refers to the method in which the concept of security maket line has been introduced. According to this concept the relationship between the market rate of returns and the portfolio returns is defined with the help of a curve in which the slope of the curve measures the volatility between the market and the portfolio. The Treynor measure is generally used when the a particular sub portfolio has to be analyzed out of a set of large number of portfolios. Sharpe ratio is probably similar to the Treynor measure only that the risk involved in the venture is measured with the help of standard deviation of the portfolio rather than just considering the market risk involved. This method is used when the portfolio acts as a representative of the entire investment. Lastly the most effective measure is the Jensen measure which is primarily based on Capital Asset Pricing Model. This method tends to measure the excess return over the estimated or expected rate of return and the return is measured with the help of alpha. The Jensen measure is used to calculate the amount that is to be payable to the portfolio manager. For an instance a particular manager managing more than one investments in hand will obviously compare them to each other on the basis of the above measures provided and select the one with optimum rate or return as well optimum percentage of risk involved. Therefore this is the way in which the effectiveness and rate of return can be measured thus helping the investors to select the venture in which the investment has to be done (Unger, Gemnden and Aubry 2012). Referencing Dempsey, M., 2013. The capital asset pricing model (CAPM): the history of a failed revolutionary idea in finance?. Abacus, 49(S1), pp.7-23. Woodford, M., 2012. Methods of policy accommodation at the interest-rate lower bound. The Changing Policy Landscape, pp.185-288. Unger, B.N., Gemnden, H.G. and Aubry, M., 2012. The three roles of a project portfolio management office: Their impact on portfolio management execution and success. International Journal of Project Management, 30(5), pp.608-620.