Need help with my writing homework on What Is the Relevance of Portfolio Theory to an Investor or Fund Manager in a Typical Equity Market. Write a 2000 word paper answering; Equities are not similar to to the unincorporated businesses’ owners if such businesses turned bankrupt. (Jorion, 2007 pp209, 210)
This study is going to focus on equity markets and more specifically there will be vivid answers provided to the study questions. The questions are. “What is the relevance of portfolio theory to an investor or fund manager in a typical equity market? and What is the relevance of the Capital Asset Pricing Model (CAPM) to an investor or fund manager in an equity market?” These questions are going to be tackled in the order in which they are presented.
Prior to the modern portfolio theory, management of investments was a process of two dimensions with a fundamental focus on return and volatility characteristics of stocks individually. Subsequently, the work conducted by Harry Markowitz resulted to stakeholders realizing the essentiality of the relationship among stocks belonging to a given portfolio. The theory of modern portfolio brought in the third dimension with regards to the management of the portfolio, which evaluates a given stock’s diversification impact upon a portfolio. Diversification impact is the effect of including a specific asset or class of stocks to the return as well as volatility characteristics of the portfolio in entirety.
Modern portfolio theory, therefore, brought into focus the consideration of the whole portfolio as opposed to individual stocks. Thus, the idea of diversification had to be reconsidered at the same time. The notion of optional diversification, which is usually used under the stock’s diversification, surpasses the idea of simply utilising a number of stock baskets to getting baskets which are specifically different from each other.
This is of ample importance since a basket’s unique returns’ pattern specifically offsets the returns of the others, which results to the smoothing the volatility of the overall portfolio. .