The process of portfolio construction can be quite complex. Analysts go through reams of statistics - past performance, future potential, and industry knowledge and rely on personal insights into the market to arrive at the final list (UOP, 2008). This memo will be based on the Constructing and Managing a Portfolio Simulation which details the fundamentals of portfolio construction in relation to the risk-return tradeoff and the relationship between investment strategy and investment performance. As a treasury analyst for Casa Bonita Ceramics, I was tasked to select the best stocks and allocate company resources to construct a portfolio. This memo will detail my decisions made in the simulation, discuss the Sharpe ratio and how it relates to investment decisions, and lastly, provide recommendations for changes in the organization's investment strategy in order to improve its investment performance.
Simulation DecisionsFrom excess cash generated in 2004, the company decided to invest $800,000 in the stock market in which eight stocks had already been chosen.
With the consideration of a high return without the risk of losing capital in mind, I narrowed it down to the final four stocks worth investing in: Desktop, Inc., Levinthal Defense Systems, Transconduit, Inc., and Goldstein and Delaney Bank. This was an astute stock selection and showed good judgment by diversifying the stock selection to reduce stock-specific risks.
The next task was to allocate the $800,000 in a manner that maximized portfolio return and kept the portfolio risk below 22 percent. I chose to distribute the funds evenly between the four stocks which resulted in 20.45% portfolio risk, 12.74% portfolio return, and a Sharpe ratio of 38.46%. This was a good decision considering management would not approve of any risks above 22 percent which did not allow more funds to be allocated in stocks with higher returns and...