High Risk Investing : Low Risk Portfolio Essay

2762 Words Oct 20th, 2016 12 Pages
Low Risk Investing: Low Risk Portfolio of Stocks or Portfolio of Low Risk Stocks
Modern Portfolio Theory (MPT) introduced by Harry Markowitz [1952], Jack Treynor [1962], William Sharpe 1964, John Lintner [1965], and Jan Mossin [1966] states, expectation of return must be accompanied by risk, the variation (volatility) around the expected return. Volatility is uncertainties around expectations that investors may lose their investment due to unexpected fluctuation in the market price of securities. Moreover, a decision to hold a security should not be made solely on its expected return and variation around it, but rather a decision to hold any security depends on what other securities the investor wants to hold. MPT assumes that higher risk is compensated on average by higher returns. MPT established the Capital Asset Pricing Model (CAPM) which further provided the framework for examining risk and return relationship by introducing the concept of diversifiable and non-diversifiable risk. The variation around an expected return can be decomposed into non-diversifiable and diversifiable portions. The non-diversifiable portion of is known as the systematic risk. It is the risk that affects the entire market. The global financial crisis of 2008 is an example of a systematic risk. The diversifiable portion is known as the unsystematic risk. It is the risk that is associated with an individual security or an investment. For example, if a side-effect of a drug…

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