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Portfolio Diversification deals with choosing a group of assets with very low correlation to one another in order to reduce the risk of investing. An investor’s incentive for putting their capital into
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Portfolio Diversification Shalenta Hardison Fatih Akduman Andro Bibileishvili Financial Management March 30, 2006 Table of Contents: 1. Executive Summary 3 2. Key Terms 4 3. Theories and Applications 5 3.1 Perfect Portfolio Effect- Investing in Apples and Pears 5 3.2 Modern Portfolio Theory 6 3.2.1 Risks 7 3.2.2 Efficient Frontier & Portfolio Diversification 9 3.3 The Sharpe Ratio 11 3.4 Capital Asset Pricing Model 12 3.4.1 Security Valuation and Discount Rates 12 3.4.2 Discount Rate- Three Major Components 13 3.4.3 Risk Free Rate 14 3.5 The Arbitrage Pricing Theory 15 4. Risk and Return Calculations 16 4.1 Covariance and Correlation in Measuring Risk 17 5. Mean Variance Optimisation 19 5.1 Single Period Problem 19 5.2 Multi-period Problem 20 5.3 Benefits of MV optimiser 20 5.4 The Markowitz Optimization Enigma 21 5.5 Markowitz Mean-Variance Efficient frontier 22 5.6 Exact VS Approximate MV Optimizers 23 6. Conclusion 24 7. Bibliography 25 1. Executive Summary Portfolio Diversification deals with choosing a group of assets with very low correlation to one another in order to reduce the risk of investing. An investor's incentive for putting their capital into certain markets for a particular length of time is done in order to receive a return on their investment. Managing the...
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