The portfolio theory used for making the portfolio is Capital Asset Pricing Model Theory. According to the theory, when an investor buys a riskier stock, he would like to get rewarded for the extra risk he is taking by buying that stock. Hence, in situation of market equilibrium, a stock should provide an expected return that compensates for the amount of risk, in particular, systematic risk that cannot be avoided through diversification, associated with it. The greater the systematic risk associated with that stock, the higher the returns the investor would expect from it. The model explains the relationship between the systematic risk associated with a stock and its expected return. In this model a stock’s expected return is the risk free rate of return (generally return on Govt. Treasury bonds is taken as risk free rate of return) plus a risk premium based on the stock’s systematic risk.
The portfolios once build needs to be rebalanced and churned on at different time perspectives. This part analyzes the rebalancing strategies used and the theory underlying those strategies. There are many reasons why the portfolio may have to be changed. According to the utility theory, the risk taking ability of the investor increases with the increase in wealth. It says that people can afford to take more risks as they grow rich and benefit from their rewards. Also, as time passes some events take place that may have an impact on the time horizon of the investor. Also, with time market opportunities and liquidity needs of the investor inspires to rebalance the portfolio. Fluctuations in the stock markets often provide opportunities for the investors in both positives as well as negative aspects. The disciplined investment decisions land value by providing the objective basis to confidently pursue uncomfortable investments.