Modern Financial Systems: Theory and Applications

CHAPTER 14

Marketable Securities Portfolios

Chapter 14 considers managing portfolios consisting mainly of publicly traded securities. The chapter develops the essentials of the capital asset pricing theory (CAPT) and of the arbitrage pricing theory (APT), then uses the theories to provide static benchmark valuations for both portfolios and the securities the portfolios contain. The chapter also examines dynamic aspects of portfolio management, using earlier discussions of derivatives pricing to illustrate the basics of dynamic hedging theory and the construction of insured portfolios. In applications, the chapter considers why small investors buy mutual funds and exchange-traded funds, as well as the popularity of hedge funds. Finally, it discusses the measure known as Value at Risk (VaR).

INTRODUCTION

Portfolio governance tasks depend on the kind of portfolio being held. A relatively liquid portfolio (i.e., one that mostly contains marketable securities) presents the tasks of acquiring securities with desirable risk-return trade-offs, monitoring the securities’ performance, and selling them if their performance does not live up to expectations. Governance of a marketable securities portfolio begins with developing and screening a list of candidate securities from which the portfolio will be assembled. Portfolio managers will usually begin by selecting securities intended to generate a favorable risk-return trade-off, largely along lines suggested by the CAPT and the APT. After ...