Topic 2 - Topic2:PortfolioTheory, selection&investing...

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Topic 2: Portfolio Theory,  Portfolio risk and return Modern portfolio theory Markowitz portfolio selection Efficient portfolio and efficient frontier
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Investment Decisions Involve uncertainty Focus on expected  returns Estimates of future returns needed to  consider and manage risk Goal is to reduce risk without affecting  returns Accomplished by building a portfolio DIVERSIFICATION is the key
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Dealing With Uncertainty Risk that an expected return will not be  realized Investors must think about return  distributions, not just a single return Probabilities weight outcomes Should be assigned to each possible  outcome to create a distribution Can be discrete or continuous
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Expected return E(R p ) =  Σ  w E(R i Expected risk σ 2 p Σ w σ 2 i * Investors can reduce the risk of a portfolio through diversification, hence, a portfolio’s risk is not just the sum of weighted average of individual securities’ risk
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Modern Portfolio Theory Background assumption and definitions Investors want to maximize the investment returns  for a given level of risk A portfolio includes all the assets and liabilities of  the investor Investors are risk averse, i.e. given equal rates of 
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This note was uploaded on 10/04/2011 for the course FINANCE FINANCE taught by Professor Don'tknow during the Spring '09 term at American Internation College.

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Topic 2 - Topic2:PortfolioTheory, selection&investing...

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