Risk and Return Tradeoff Memo
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, 2009). Every investor aims to maximize returns while minimizing risk. Individual securities must be evaluated not only on the risk-return trade-off in isolation but also on their contribution to the risk-return tradeoff of the entire portfolio. This memo will be based on the Constructing and Managing a Portfolio Simulation that 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.
From 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...