InvestmentPlanningWeek4_2 - FSU Certificate in Financial...

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FSU Certificate in Financial Planning Investment Planning © Florida State University Page 1 Lecture Title: Week 4: Returns and Probability, Source and Measurement of Risk, Modern Portfolio Theory Week 4: Risk and Portfolio Theory – Part 1 Introd uctio n Last week we knocked the rust of our calculators and worked through an extensive array of calculations. We had less reading, but made up for it by carefully reviewing both the situational reasoning and mechanical functioning required to solve various real life problems. This week we go from the concrete to the abstract as we begin our two-week study of risk and portfolio management. In week six, we'll review the material learned in the first half of the course and take the midterm exam. If you're not already somewhat familiar with the material found in Chapter 5, you'll need to read it a couple of times. I would suggest you read it once, then go back and read these notes and follow in the text. This week's notes are in an order that coincides with the text. Important Note: The information presented in the text beginning the bottom of page 153 up to the discussion of Beta and the Security Market Line on page 159 is not necessary for you to learn with the exception of the paragraph on page 156 that begins "If a stock has a beta of 1.0..." A friendly tip: If some of this doesn't sink in immediately take a break and come back refreshed. As Nietzsche said, "If you gaze for long enough into the abyss, the abyss also gazes into you." If you have a Tinkerbell or Peter Pan costume in the closet you may want to wear it while reading Chapter 5. At times, it will seem we're flying in and out of Never Neverland and you'll want to be appropriately dressed. Remember to change into something else before you go out to dinner (unless you live in Key West). In a perfect world, modern portfolio theory and all its ramifications would work perfectly well all the time because it is based on logical thought processes. The problem is this isn't a perfect world; if it were, the greatest action movie actor of all time would be the former Governor of California or something. Oh my! See how confusing this reality versus fiction stuff is? Well, we know modern portfolio theory is real to the Certified Financial Planner Board of Standards, Inc. (CFP Board), so let's learn it.
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FSU Certificate in Financial Planning Investment Planning © Florida State University Page 2 Objectives At the end of this lecture, you will be able to: 1. Identify and characterize the sources of risk. 2. Differentiate between expected and realized return. 3. Explain how the terms: standard deviation, beta, efficient frontier and diversification apply in portfolio theory. 4. Contrast efficient and inefficient portfolios. 5. Use the capital asset pricing model and arbitrage pricing theory to compare a stock's return.
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