Abstract
This essay is concerned with understanding the key issues relative to portfolio analysis and investment. The scope of this essay will be limited to the U. S. Stock markets only. This essay will be built upon extant portfolio theory and will discuss different types of risks that investors might face and how they go about managing such risks. Under consideration will be topics such as efficient frontier and optimal portfolios as well as their relevance to investment theory, under the assumption of direct investment in the stock market.
DETERMINING THE PURPOSE OF YOUR INVESTMENT
One of the steps in building an investment portfolio is to establish investment goals. Investment goals are the financial objectives you wish to achieve by investing (Gitman and Joehnk, 2005). In other words, what you want these investments to do for you or why you are investing in the first place. Some common investment goals include (Gitman, et al, 2005): 1) accumulating retirement funds, 2) enhancing current income, 3) saving for major expenditures, or 4) sheltering income from taxes. To get an estimate of the securities suitable for certain levels of risk tolerance and to maximize returns, investors should have an idea of how much time and money they have to invest and the returns they are looking for (Investopedia.com, 2006).
MODERN INVESTMENT THEORY
Modern Investment Theory also known as Modern Portfolio Theory (MPT) was introduced by Harry Markowitz with his paper "Portfolio Selection," which appeared in the 1952 Journal of Finance (riskglossary.com, 2006). Prior to Markowitz's work, investors focused on assessing the risks and rewards of individual securities that offered the best opportunities for gain with the least risk and then construct a portfolio from these (riskglossary.com, 2006).
MPT is defined, according to investorwords.com (2005), as an overall investment strategy that seeks to construct an optimal portfolio by considering the relationship between risk and return, especially measured by alpha, beta, and R². MPT utilizes several basic statistical measures to develop a portfolio plan (Gitman, et al, 2005). Included are expected returns and standard deviations of returns for both securities and portfolios, and the correlation between returns (Gitman, et al, 2005). Detailing the mathematics of diversification, Markowitz proposed that investors focus on selecting portfolios based on their overall risk-reward characteristics instead of merely compiling portfolios from securities that individually have attractive risk-reward characteristics (riskglossary.com, 2006). This theory proposes that the risk of a particular stock should not be looked at on a standalone basis, but rather in relation to how that particular stock's price varies in relation to the variation in price of the market portfolio (investorwords.
The purpose of this paper is to provide a summary of the article called “Can We Keep Our Promises?” by Robert D. Arnott, and to help better understand the three key risks facing each investor.
The Accounting Principles II portfolio project helped me become familiar with accounting practices used to complete routine financial tasks. This course helped me learn how to complete routine business transactions, discover and explain financial issues in companies and create and manage ledgers for employers. The Accounting Principles II portfolio project taught me how to manage companies’ journals, income statements, cash flow statements and closing statements in ledgers. The Bryant Stratton Online college program outcomes helped me learn about merchandising laws, rules and approaches used in corporations. These outcomes helped me learn and distinguish practices used to create, track and manage product inventories when I am completing tasks
Dimensional's value strategies are based on the Fama/French research in multifactor portfolios designed to capture the return premiums associated with high book-to-market (BtM) ratios.
Market Risk is also known as Systematic Risk due to its broad impact on investments. The level of Market Risk depends on the probability that the entire market will decline and drag down the values of all companies. With Market Risk, investors stand to lose value irrespective of the companies, business sectors, or investment vehicles they are invested in. It can be difficult for investors to protect themselves against market risk, since investment strategies, like diversification, is mostly ineffective (Investopedia,
Investment theory is based upon some simple concepts. Investors should want to maximize their return while minimizing their risk at the same time. In order to accomplish this goal investors should diversify their portfolios based upon expected returns and standard deviations of individual securities. Investment theory assumes that investors are risk averse, which means that they will choose a portfolio with a smaller standard deviation. (Alexander, Sharpe, and Bailey, 1998). It is also assumed that wealth has marginal utility, which basically means that a dollar potentially lost has more perceived value than a dollar potentially gained. An indifference curve is a term that represents a combination of risk and expected return that has an equal amount of utility to an investor. A two dimensional figure that provides us with return measurements on the vertical axis and risk measurements (std. deviation) on the horizontal axis will show indifference curves starting at a point and moving higher up the vertical axis the further along the horizontal axis it moves. Therefore a risk averse investor will choose an indifference curve that lies the furthest to the northwest because this would r...
Make financial goals- It is very important for you to make financial goals that you can meet. When you are planning wealth management, it is very important for you to plan your investments in advance. Understand what your financial goals are. For some people, buying that car or house is a financial goal.
This one’s a bit trickier, I know. It requires you to think about how risk averse you are (i.e., how much would you freak out if you lost a little, some, or a boatload of your investment portfolio) and to consider the types of investments that are likely to help you get to the investment return you’re comfortable with.
To maximize optimum performance of our investment portfolio, we placed a certain percentage of equity in different sectors of the stock market.
Capital Asset Pricing Model (CAPM) is an ex ante concept, which is built on the portfolio theory established by Markowitz (Bhatnagar and Ramlogan 2012). It enhances the understanding of elements of asset prices, specifically the linear relationship between risk and expected return (Perold 2004). The direct correlation between risk and return is well defined by the security market line (SML), where market risk of an asset is associated with the return and risk of the market along with the risk free rate to estimate expected return on an asset (Watson and Head 1998 cited in Laubscher 2002).
Define goals for your savings. When you set goals for your savings, make sure to do it the SMART way. It should be specific, measurable, attainable, realistic and timely. Let's go through them one by one below.
Asset allocation decisions made by an investor are considered more important than other decisions such as market timing or security selection. In the research provided by Hensel (1991), performance attribution is one of the main components when choosing the right assets in a portfolio. The impact of any investment decision can be measured by comparing its outcome with the outcome of some alternative decision. Furthermore, according to Hensel (1991), every investor has to incorporate the minimum-risk portfolio, which is a combination of securities or asset classes that reduces the uncertainty of future portfolio returns to a minimum.
In this research paper, we examine the distinct theories of traditional and behavioural finance, linking them to efficient market hypothesis. The scope of the paper covers market anomalies as well as behavioural biases of individuals/analysts and the impact of such on portfolio construction. Over the last two (2) decades, behavioural finance has been growing steadily. This growth is associated with the realization that investors rarely behave according to the assumptions made in traditional finance and economics.
Financial planning involves short and long-term investment strategies. A short-term strategy is one that an individual would want to see results in one to two years. “Most investment advisors say your first short-term goals should be getting your financial house in order by eliminating credit card debt and establishing a rainy day fund” (Mutual Fund Store, 2014). Mutual Fund Store explains that intermediate-term and long-term goals includes buying a house, starting a business, and retiring according to each person’s own schedule and lifestyle. Prior to saving and investing for one’s...
I am currently majoring in Finance Management. Most of the time people think of finance as just managing money. However, finance is needed for so much more! The finance industry deals with starting businesses, developing new products, expanding markets, as well as everyday things like saving for retirement, purchasing a home, and even insurance. The stock market, asset allocation, portfolio analysis, and electronic commerce are all key aspects in finance. In this paper, I will explain how these features play a vital role in the industry, along with the issues that come with these factors.
The Modern portfolio theory {MPT}, "proposes how rational investors will use diversification to optimize their portfolios, and how an asset should be priced given its risk relative to the market as a whole. The basic concepts of the theory are the efficient frontier, Capital Asset Pricing Model and beta coefficient, the Capital Market Line and the Securities Market Line. MPT models the return of an asset as a random variable and a portfolio as a weighted combination of assets; the return of a portfolio is thus also a random variable and consequently has an expected value and a variance.