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4. Portfolio Diversification and Weighting Implications for Expected Returns Implications for Variance Portfolio Considerations Introduction to Risk and Return > Portfolio Considerations Free to share, print, make copies and changes. Get yours at www.boundless.com www.boundless.com/finance?campaign_content=book_192_section_77&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=dir ect&utm_source=boundless

5. Diversification is the idea of spreading a portfolio across different classes of investments with a target weight attached to each class. Modern portfolio theory is the idea that for any investment objective, there is an optimal mix of investments that can maximize expected return subject to a specific risk threshold. Systemic risk is the risk that applies to a particular market or industry. It cannot be diversified away. Specific risk is the risk that applies to one particular investment within a market and it can be diversified away. Portfolio Diversification and Weighting Free to share, print, make copies and changes. Get yours at www.boundless.com www.boundless.com/finance/textbooks/boundless-finance-textbook/introduction-to-risk-and-return-8/portfolio-considerations-77/portfolio- diversification-and-weighting-342- 3796?campaign_content=book_192_section_77&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boundl ess Diversified Portfolio View on Boundless.com Introduction to Risk and Return > Portfolio Considerations

6. Asset allocation is a theory of designing a portfolio that achieves a weighting scheme with a target mix of different asset classes that is suitable to the time frame and risk tolerance of the investor. The principals that support the theory of asset allocation are the cyclical nature of investments within a particular class of assets and weaker or even negative correlations that often exist across asset classes. When you re-balance your portfolio after it has deviated from the original target mix, you are selling classes that have relatively appreciated in order to buy those which have relatively depreciated. If you believe that markets go in cycles, you should believe in selling assets that have relatively appreciated and buying those which have relatively depreciated. Implications for Expected Returns Free to share, print, make copies and changes. Get yours at www.boundless.com www.boundless.com/finance/textbooks/boundless-finance-textbook/introduction-to-risk-and-return-8/portfolio-considerations-77/implications-for- expected-returns-343- 7275?campaign_content=book_192_section_77&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boundl ess Average Returns for Different Weighting Schemes View on Boundless.com Introduction to Risk and Return > Portfolio Considerations

7. Portfolio managers often target a mix of assets across different categories that maximize potential return and limit specific risk. Portfolio managers choose from many more classes of assets than the two that have been used primarily for this chapter. With historical data, powerful software and a proficient financial analyst, a correlation matrix can be produced that helps portfolio managers make investment decisions that will limit the portfolio's overall risk and exposure to market downturns. Implications for Variance Free to share, print, make copies and changes. Get yours at www.boundless.com www.boundless.com/finance/textbooks/boundless-finance-textbook/introduction-to-risk-and-return-8/portfolio-considerations-77/implications-for- variance-344- 7540?campaign_content=book_192_section_77&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boundl ess Illustration of Modern Portfolio Theory View on Boundless.com Introduction to Risk and Return > Portfolio Considerations

8. Free to share, print, make copies and changes. Get yours at www.boundless.com Appendix

9. Key terms Correlation Matrix A matrix that shows a set of correlations between two random variables over a number of observations. Strategic Asset Allocation The primary goal of a strategic asset allocation is to create an asset mix that will provide the optimal balance between expected risk and return for a long-term investment horizon. systemic risk Refers to the risk common to all securities which cannot be diversified away. Free to share, print, make copies and changes. Get yours at www.boundless.com Introduction to Risk and Return

10. Average Returns for Different Weighting Schemes Different returns are expected for different asset allocations given historical averages Free to share, print, make copies and changes. Get yours at www.boundless.com Wikipedia. "Asset allocation." GNU FDL http://en.wikipedia.org/wiki/Asset_allocation View on Boundless.comGNU FDLhttp://en.wikipedia.org/wiki/Asset_allocationView on Boundless.com Introduction to Risk and Return

11. Illustration of Modern Portfolio Theory Diversifying asset classes can reduce portfolio variance without diminishing expected return Free to share, print, make copies and changes. Get yours at www.boundless.com Wikipedia. "Markowitz frontier." CC BY-SA http://en.wikipedia.org/wiki/File:Markowitz_frontier.jpg View on Boundless.comCC BY-SAhttp://en.wikipedia.org/wiki/File:Markowitz_frontier.jpgView on Boundless.com Introduction to Risk and Return

12. Diversified Portfolio Asset classes and their weightings for a particular portfolio Free to share, print, make copies and changes. Get yours at www.boundless.com Wikipedia. "Asset allocation." GNU FDL http://en.wikipedia.org/wiki/Asset_allocation View on Boundless.comGNU FDLhttp://en.wikipedia.org/wiki/Asset_allocationView on Boundless.com Introduction to Risk and Return

13. Free to share, print, make copies and changes. Get yours at www.boundless.com Introduction to Risk and Return What factors should be considered when weighting an investment portfolio? A) All of these answers. B) The time frame of the investment. C) The investor's risk tolerance. D) The specific risks of the individual securities.

14. Free to share, print, make copies and changes. Get yours at www.boundless.comwww.boundless.com Boundless - LO. "Boundless." CC BY-SA 3.0 http://www.boundless.com/CC BY-SA 3.0http://www.boundless.com/ Introduction to Risk and Return What factors should be considered when weighting an investment portfolio? A) All of these answers. B) The time frame of the investment. C) The investor's risk tolerance. D) The specific risks of the individual securities.

15. Free to share, print, make copies and changes. Get yours at www.boundless.com Introduction to Risk and Return A portfolio has $70,000 of bonds and $30,000 of stock. The bonds are 80% likely to have a 10% return and 20% likely to have a 0% return. The stock is 50% likely to have a 20% return and 50% likely to have a 10% loss. What is the expected return? A) 7.1% B) 5.9% C) 2.9% D) 13%

16. Free to share, print, make copies and changes. Get yours at www.boundless.comwww.boundless.com Boundless - LO. "Boundless." CC BY-SA 3.0 http://www.boundless.com/CC BY-SA 3.0http://www.boundless.com/ Introduction to Risk and Return A portfolio has $70,000 of bonds and $30,000 of stock. The bonds are 80% likely to have a 10% return and 20% likely to have a 0% return. The stock is 50% likely to have a 20% return and 50% likely to have a 10% loss. What is the expected return? A) 7.1% B) 5.9% C) 2.9% D) 13%

17. Free to share, print, make copies and changes. Get yours at www.boundless.com Introduction to Risk and Return The adequately diversify your portfolio, you need to do more than just own a variety of securities. Which of the following is a necessary component of a well-diversified portfolio that has a low variance? A) The component securities have small or negative correlation coefficients. B) The portfolio's components are in a variety of asset classes, such as commodities and derivatives. C) The portfolio is reviewed and rebalanced based on updated projections and new information. D) All of these answers.

18. Free to share, print, make copies and changes. Get yours at www.boundless.comwww.boundless.com Boundless - LO. "Boundless." CC BY-SA 3.0 http://www.boundless.com/CC BY-SA 3.0http://www.boundless.com/ Introduction to Risk and Return The adequately diversify your portfolio, you need to do more than just own a variety of securities. Which of the following is a necessary component of a well-diversified portfolio that has a low variance? A) The component securities have small or negative correlation coefficients. B) The portfolio's components are in a variety of asset classes, such as commodities and derivatives. C) The portfolio is reviewed and rebalanced based on updated projections and new information. D) All of these answers.

19. Attribution Wikipedia. "Asset classes." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Asset_classes#Asset_classesCC BY-SA 3.0http://en.wikipedia.org/wiki/Asset_classes#Asset_classes Wikipedia. "Modern portfolio theory." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Modern_portfolio_theoryCC BY-SA 3.0http://en.wikipedia.org/wiki/Modern_portfolio_theory Wikipedia. "systemic risk." CC BY-SA 3.0 http://en.wikipedia.org/wiki/systemic%20riskCC BY-SA 3.0http://en.wikipedia.org/wiki/systemic%20risk Wikipedia. "Modern portfolio theory." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Modern_portfolio_theoryCC BY-SA 3.0http://en.wikipedia.org/wiki/Modern_portfolio_theory Wikipedia. "Asset allocation." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Asset_allocationCC BY-SA 3.0http://en.wikipedia.org/wiki/Asset_allocation Wikipedia. "Strategic Asset Allocation." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Strategic%20Asset%20AllocationCC BY-SA 3.0http://en.wikipedia.org/wiki/Strategic%20Asset%20Allocation Wikipedia. "Asset allocation." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Asset_allocationCC BY-SA 3.0http://en.wikipedia.org/wiki/Asset_allocation Wikipedia. "Stock market downturn of 2002." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Stock_market_downturn_of_2002CC BY-SA 3.0http://en.wikipedia.org/wiki/Stock_market_downturn_of_2002 Wikipedia. "Correlation Matrix." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Correlation%20MatrixCC BY-SA 3.0http://en.wikipedia.org/wiki/Correlation%20Matrix Wikipedia. "Covariance and correlation." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Covariance_and_correlationCC BY-SA 3.0http://en.wikipedia.org/wiki/Covariance_and_correlation Free to share, print, make copies and changes. Get yours at www.boundless.com Introduction to Risk and Return