The modern portfolio theory

Résumé du document

The aim of the Modern Portfolio Theory is to provide to a portfolio owner the tools necessary to implement an efficient and sustainable strategy focusing on minimizing the risk. According to this theory, risk is supposed to be reduced through the choice of a diversified portfolio. In fact, enlarging the scope of investments on a large range of market allows for the reducing of the risk by being less dependent of a single value. In addition, the application of the theory allows the trader to determine the value of an asset comparing the potential return with the risk. Several theories have been established to determine this value and the following paper will focus on the followings, Markowitz and the capital asset model, which are considered to be the most efficient. An efficient trading strategy doesn't mean to take major risk in order to get high return, it appears crucial to reduce the risk as much as possible in order to benefit from a sustainable growth of the portfolio's value. Regarding the Modern Portfolio Theory, the first key point to analyze appears to be the relationship between the risk and the potential return.

Extraits

[...] Km is average return on the market. K provides information about the value of the stock. It takes into consideration the Beta (stock risky or not), the risk free rate (risk of bankruptcy based on US treasury bonds) as well as the return on the average stock in the market. K is a financial tool in order to know how much interesting the stock is for a shareholder. K provides the amount into percentage of how much the company has to give back in term of return on the initial investment. [...]

[...] In this way, we can say the risk is shared by the portfolio's values. This diversification is also a balance between the risk and the return; through this process, the portfolio's owner decreases the potential losses as well as the potential profits. As we said before, gambling on quick and high return is not a good strategy to follow; we will prefer to implement a sustainable growth reducing the risk as much as possible. To concretize this theory, we will analyse the equilibrium of the portfolio through the major factor to take into consideration. [...]

[...] Our main expectation was the clarification of the situation of Google. Regarding the evolution we were very satisfied about it because we made more than 30 000$ only on Google. conclusion REGARDING OUR STRATEGY, WE BOTH INVESTED ACTIVELY AND PASSIVELY. AS REGARDS TO THE DEFINITION, WE INVESTED PASSIVELY IN ASSET CLASSES CONSIDERED TO BE VERY EFFICIENT, AND WE INVESTED ACTIVELY IN ASSET CLASSES CONSIDERED TO BE LESS EFFICIENT. IN ADDITION, THROUGH THE STOCKTRAK, WE HAD THE OPPORTUNITY TO USE TECHNICAL AND FUNDAMENTAL ANALYSIS. [...]

[...] Tobin, James (1958). Liquidity preference as behavior towards risk, The Review of Economic Studies 65-86. Markowitz, Harry M. (1952). Portfolio Selection, Journal of Finance 77-91. http://www.investorhome.com/process3.htm Tom Petruno, LA Times A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing, Ninth Edition by Burton G. Malkiel (Paperback - Dec 24, 2007). [...]

[...] On the one hand, passive investing consists in purchasing diversified portfolios of all the securities in an asset class. On the other hand, active investing consists in overweighting securities and sectors within an asset class believed to be undervalued and underweighting securities and sectors believed to be overvalued. In this way, the example of the purchase of a stock is an active investment that can be measured against the performance of the stock market itself. In comparison to a passive investment in a stock index, purchase of an individual stock can be viewed as a combination of an asset allocation to stocks and an active investment in that stock with the belief that it will outperform the stock index”.[2] Passive investing includes several advantages versus active investing; reduced costs, tax efficiency, Passive funds outperform a majority of active funds. [...]