“PORTFOLIO INSURANCE – DYNAMIC ASSET ALLOCATION STRATEGY”

COURSE CODE – F-503

GROUP: FINANCE
UNIVERSITY OF DHAKA

PREPARED FOR
Dr. Mahmood Osman Imam
Professor of Finance
Department of Finance
University of Dhaka


March 28, 200..


Dr. Mahmood Osman Imam
Professor of Finance
Department of Finance
University of Dhaka

Dear Sir,

It is my immense pleasure to submit my class report as you asked me to prepare and submit as a requirement of Financial Derivatives course (F-503) on "Portfolio Insurance – Dynamic Asset Allocation Strategy ".

I have tried my best to compile the pertinent information as comprehensively as possible and if you need any further information, I will be obliged to assist you.

Thanking you,

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ACKNOWLEDGEMENTS

At first I would like thank our course teacher Dr. Mahmood Osman Imam for giving us such an important job like managing the portfolio insurance using dynamic asset allocation strategy.

During the preparation of the report we did have some problem that has been erased out with your propound lecture and assistance. Without your cooperation and guideline this report would have been an incomplete one. Finally thank you for your supportive thought and kind consideration for formulating an idea.


Table of Contents

1. Executive Summary
2. Management of Equity Risk
3. Asset Allocation Strategies
4. Portfolio Insurance
5. Dynamic Asset Allocation Strategy
6. Industry Analysis
7. Company Analysis
8. Information
9. 100% Equity Investment
10. 50% Equity and 50% Bond Investment
11. Delta Calculation
12. Graphical Presentation:
Static Approach
Delta
Dynamic Approach
13. References


EXECUTIVE SUMMARY

This report “PORTFOLIO INSURANCE – DYNAMIC ASSET ALLOCATION STRATEGY " is prepared to fulfill the partial requirement of Financial Derivatives course (F-503) of MBA Program of UNIVERSITY OF DHAKA.

The objective of this report is to find out how equity risk can be managed (either eliminated or reduced) through dynamic asset allocation. This report discusses the ways of handling the risk arising from holdings of portfolio of risky assets and riskless assets that means how to manage insured portfolio which is a hedging technique frequently used by institutional investors when the market direction is uncertain or volatile. Portfolio insurance is a dynamic trading strategy designed to protect a portfolio from market declines while preserving the opportunity to participate in market advances.

Several portfolio insurance methods exist and are used in practice. The best known strategy involves trading in ‘real’ and / or ‘synthetic’ options. For some reasons, most investors prefer not to use the option market for insuring the portfolio. Hence it calls for the dynamic trading strategy replicating the option strategy to insure the portfolio. In this strategy, the manager replicates an option through continuously revising the proportions of a portfolio consisting of the underlying risky asset (stock/bond) and the riskless asset (bond/T-bill) to insure portfolio’s value.

In this report I have to analyze the industry and company to select the securities to invest. First I construct two portfolios one investing 100% in equity another investing 50% in equity and 50% in bonds. Total amount of investment is 5,00,000 taka. And assumed bond rate was 7%. After static approach I found out Delta. Delta tells us the number of shares to be hold to hedge the portfolio. Delta is the differences between higher and lower value of 50% equity investment divided by the differences between higher and lower value of 100% equity investment. Here I assume that there is a 90% chance to realize the higher value and 80% chance to realize the lower value. Then I assign the portfolio according to delta and find out the insured value.