Modern Portfolio Theory: The Framework Of Modern Portfolio Theory

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Investing in financial markets can carry risk and long term adverse effects. When deciding to participate in financial markets, an investor must educate themselves in order to financial blunders. At the forefront of financial theory, Modern Portfolio Theory asses the maximum expected portfolio return for a given amount of portfolio risk. Within the framework of Modern Portfolio Theory, an optimal portfolio is constructed on the basis of asset allocation, diversification and rebalancing. In conjunction with diversification, asset allocation is the strategy of dividing a portfolio across various asset classes. Furthermore, optimal diversification involves holding multiple instruments that are not positively correlated. While diversification and asset allocation can improve returns, systematic and unsystematic risks remain inherent in investing. Introduced by Harry Markowitz in 1952, the concept of an efficient frontier identifies an optimal level of diversification and asset …show more content…

Simply put, both alpha and beta are risk ratios designed to determine the risk reward profile of investment …show more content…

CAPM helps investors measure the investment risk and expected return to appropriately price the asset. In particular, investors must be compensated for the time value of money and risk. The risk free rate, typically a Treasure Bond or Stock Index, represents the time value of money for placing money in any investment. Simply put, the mean return of a security should be linearly related to its Beta coefficients. This shows that riskier investments earn a premium over the benchmark rate. Following a risk to reward framework, the expected return, under a CAPM model, will be higher when investor bares higher

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