I. UNIT TITLE/CHAPTER TITLE: CHAPTER V
II. LESSON TITLE : THEORY FOR INVESTMENT PORTFOLIO FORMATION
III. LESSON OVERVIEW
The lesson introduce the modern theory of investment as follows: Markowitz
portfolio theory, the capital asset pricing model and arbitrage pricing theory. The student
will learn its component and concept; formulas on how it will be computed; and analyzed
the results.
IV. LESSON CONTENT
THE MARKOWITZ PORTFOLIO THEORY
In 1952, an American economist named Harry Markowitz wrote his dissertation on
“Portfolio Selection”, a paper that contained theories which transformed the landscape of
portfolio management—a paper was published in the Journal of Finance in the same year
and would earn him the Nobel Prize in Economics nearly four decades later.
Instead of focusing on the risk of each individual asset, Markowitz demonstrated that a
diversified portfolio is less volatile than the total sum of its individual parts. While each asset
itself might be quite volatile, the volatility of the entire portfolio can actually be quite low.
Markowitz created a formula that allows an investor to mathematically trade off risk tolerance
and reward expectations, resulting in the ideal portfolio.
This theory was based on the two main concepts:
1. Every investor’s goal is to maximize return for any level of risk
2. Risk can be reduced by diversifying a portfolio through individual, unrelated securities.
CAPITAL ASSET PRICING MODEL (CAPM)
The basic theory that links return and relevant risk for all assets is the capital asset pricing model
COMPONENT OF RISK
The risk of an investment consists of two components as follows:
1. Diversifiable risk (unsystematic risk) – results from uncontrollable or random events
II. LESSON TITLE : THEORY FOR INVESTMENT PORTFOLIO FORMATION
III. LESSON OVERVIEW
The lesson introduce the modern theory of investment as follows: Markowitz
portfolio theory, the capital asset pricing model and arbitrage pricing theory. The student
will learn its component and concept; formulas on how it will be computed; and analyzed
the results.
IV. LESSON CONTENT
THE MARKOWITZ PORTFOLIO THEORY
In 1952, an American economist named Harry Markowitz wrote his dissertation on
“Portfolio Selection”, a paper that contained theories which transformed the landscape of
portfolio management—a paper was published in the Journal of Finance in the same year
and would earn him the Nobel Prize in Economics nearly four decades later.
Instead of focusing on the risk of each individual asset, Markowitz demonstrated that a
diversified portfolio is less volatile than the total sum of its individual parts. While each asset
itself might be quite volatile, the volatility of the entire portfolio can actually be quite low.
Markowitz created a formula that allows an investor to mathematically trade off risk tolerance
and reward expectations, resulting in the ideal portfolio.
This theory was based on the two main concepts:
1. Every investor’s goal is to maximize return for any level of risk
2. Risk can be reduced by diversifying a portfolio through individual, unrelated securities.
CAPITAL ASSET PRICING MODEL (CAPM)
The basic theory that links return and relevant risk for all assets is the capital asset pricing model
COMPONENT OF RISK
The risk of an investment consists of two components as follows:
1. Diversifiable risk (unsystematic risk) – results from uncontrollable or random events
