Define Portfolio Analysis

Introduction

Individual securities have risk return characteristics of their own. The future return expected from a security is variable and this variability of returns is termed risk. It is rare to find investors investing their entire wealth in a single security. This is because most investors have an aversion to risk. It is hoped that if money is invested in several securities simultaneously, the loss in one will be compensated by the gain in others. Thus, holding more than one security at a time is an attempt to spread and minimize risk by not putting all our eggs in one basket.

Most investors thus tend to invest in a group of securities rather than a single security.

Such a group of securities held together as an investment is what is known as a portfolio.

The process of creating such a portfolio is called diversification. It is an attempt to spread and minimize the risk in investment. This is sought to be achieved by holding different types of securities across different industry groups.

From a given set of securities, any number of portfolios can be constructed. A rational investor attempts to find the most efficient of these portfolios. The efficiency of each portfolio can be evaluated only in terms of the expected return and risk of the portfolio as such. Thus, determining the expected return and risk of different portfolios is a primary step in portfolio management. This step is designated as portfolio analysis.