Research, reading, research, reading

It's Friday and I've just about finished up my tasks for the first week of my Senior Project. Diving into the project, I knew there would be a lot of reading to be done to get all the knowledge I'd need to start the project, so that's pretty much what I've been doing this entire week.

I'm currently reading two textbooks to build my base of background information: Portfolio Theory and Investment Analysis by Robert Alan Hill and The Basics of Finance by Pamela Drake and Frank Fabozzi. Steadily, going through the chapters of each textbook, I'm slowly starting to learn more about what exactly portfolio theory entails, what steps go into the process of setting up a portfolio, and the different statitical measurements and tools that are used to assess the performance of portfolios.

So the first thing I'd need to know before starting my project is what I need to do to create a investment portfolio. As the figure to the right depicts, there are 5 majors steps in the process of portfolio construction:

1. Setting the investment objective

Before even beginning creating the portfolio, you must first ask, "What am I trying to accomplish here?" Are you looking to pay-off a liability in the future? Or are you simply seeking to beat out an index and balance some mix of risk and return? With a clear purpose, you can create a portfolio specialized towards an individual need.

2. Establishing the investment policy

Now we start to get into the different part the portfolio is composed of. What types of assets are you looking to include? Types of assets comomnly used include but are not limited to: bonds, common stock (i.e. large-cap, mid-cap, small-cap), and cash equivalents. How are you allocating your portfolio's resources between assets? Are you taking a growth investment approach or a value investment approach?

3. Selecting the investment strategy

Do you want to take a more active strategic approach, trying to use available market information to try and forecast the market and potentially increase the performance of your portfolio, or rather take the passive strategic approach, relying on the broad diversification of your portfolio?

4. Contructing the portfolio and monitoring portfolio

With the construction of a portfolio, it is important to create an "efficient portfolio", a portfolio that offers the greatest expected return for a given level of risk, or the lowest risk for a given expected return. Managing, monitoring, and controlling risk is a key concept of portfolio theory.

5. Measuring & evaluating performance

Different mathematical equations can be used to assess the performance of the portfol

io over specific time periods. With any portfolio, the main value we are looking for is the returns of the portfolio, and the ways we can calculate the returns. Methods include arithmatic rate of returns, time-weighted rate of returns, and dollar-weighted rate of returns, each with its advantages and disadvantages.

And this is only the first chapter of the textbook! This is definitely a lot for me to take in, but as I read and learn more, I'll be sure to report back!