Chapter 7 - Portfolio Analysis: Risk and Return in Financial MarketsFind an overview and useful learning resources below to accompany Finance and Financial Markets chapter seven.
One of the most important variables that investors have to confront when investing in financial assets is risk, and the proper definition, measurement and management of risk is essential to the study of financial markets. Investors in financial assets do not usually put all their eggs into one basket; that is, they are not usually content to place all their financial wealth into only one financial asset. Typically investors will hold a bundle of financial assets known as their asset portfolio. Generally speaking investors are concerned about two key variables, namely the risk and return on their asset portfolio. As we shall see, most investors will seek to hold what are known as efficient portfolios – portfolios that will maximize the expected return for any given level of risk, or equivalently minimize the risks for a specified expected return.
In this chapter we define risk and return, applying these concepts firstly to an individual security and then to a portfolio of securities. An important distinction is made between systematic (market) risk and unsystematic (diversifiable or specific) risk. We shall see that the latter can be eliminated through the process of portfolio diversification, while the former cannot.
- The trade-off between risk and return
- The difference between systematic and unsystematic risk
- The benefits from portfolio diversification
- The importance of the market portfolio
- The market price of risk and how to measure it
- Important key equations relating to measuring the benefits of portfolio diversification
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