Modern Portfolio Theory

Modern Portfolio Theory It quantifies the relationship between risk and return and assumes that an investor must be compensated for assuming risk. The portfolio theory is modern, inasmuch as it differs from traditional security analysis, in not attaching importance to analysis of individual investments; it tries to determine the statistical relationships between individual investments which comprise a portfolio. The four basic steps are: (a) security valuation, identifying assets in terms of their expected risk and expected return; (b) asset allocation decision, i.e., deciding how assets are to be allocated to various classes of investment, e.g., shares, bonds, gold, etc.; (c) portfolio optimization, i.e., achieving the best returns for a particular level of risk by choosing selected investment avenues; and (d) performance measurement – analysing each asset’s performance in relation to market – related and industry or individual share – related risk. With the help of this theory an investor is able to analyse, classify, and control both the kind and amount of expected risk and return from a given portfolio

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