STOCK PORTFOLIO VALUATION MODELS

 If we come across to an investor who is simply not able to endure any risk, perhaps the best asset we can advise would be US Treasury bonds. Up until now, this has been considered the lowest risk asset by everyone.

In that case, that instrument’s issuer is, whereof its name, the US Treasury, and to think that it could enter a cease payment (default) is simply impossible. But what would happen if you, my investor friend, want to earn a little “extra”… and is willing to accept larger risks in turn of better profitability.

What we should do is try to quantify not only how much the chosen asset’s risk is worth, but also quantify how much the market risk in which we are investing is worth.

Someone once told me that if the The American copper company, Southern The USA Copper Corp. were located in the US, the ADR price in the New York stock market would be up to 30% higher than what it was at that moment. That is how the market valued the “market risk prime”.

Great economists, scholars in the “profitability and risk” subject in an investment portfolio management, have tried to develop mathematical formulas in order to calculate possible return expectations in an investment beforehand, trying to minimize the universe of risks it is exposed to.

Harry M. Markowitz and James Tobin, Nobel Prize winners, developed the main theory on investment portfolios in the fifties, starting from the base that the markets tend to work more efficiently every time. This theory was the base for the subject called capital asset valuation model.

Subsequently, this theory was enhanced and expanded by William F. Sharpe, John Linter and Jack Treynor, who in the middle of the sixties complemented their predecessor’s concepts in this equilibrium model of financial assets.