Running Head: PORTFOLIO MANAGEMENT

Assignment 1: Portfolio Management

Finance 550
Strayer University
Monday, 01 February 2016

Analyze the relationship between risk and rate of return, and suggest how you would
formulate a portfolio that will minimize risk and maximize rate of return
Generally, risk and return are positively correlated (Kaunas, 2010).It is not guaranteed
that taking risks that are greater always result in higher returns. Rather when greater risks are
taken, it results in loss of larger amounts fortune. The most correct statement to say is that there
is a direct relationship between the potential of returns and a number of risks taken. In addition,
investments which have low risks have a lower potential for generating high profits (Kaunas,
2010). On the other hand, an investment involving high risks have a high potential to generate a
larger amount of capital in addition to having a high potential for loss.
The risks associated with an investment can be perceived as lying along a spectrum. On
the end of low risk, there are low bonds with low yields. The middle part of the spectrum has

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investments such as rental properties. On the end associated with high risks, there commodity
and future contracts or equity investments. On one of the end, the risk is very low, but there is no
assurance that any mint would be made out of them. On the other hand, the investments are very
risky but their high chances extremely high rewards. Investments which have different risk levels
are often placed together in portfolios for the purpose of maximizing returns while maximizing
possibilities of loss and volatilities (Reilly & Brown, 2012). Modern portfolio theories use
statistical techniques for the purpose of determining effective frontiers that result to the lowest
risks for given rates of return. For example, bonds have high rates of return than GICs and CSBs
but at the same time are riskier.This is because their prices usually drop if the creditworthiness of
the issuer reduces or the rates of interests increase. Mostly stocks have rates of returns that are
higher, but unfortunately, they are riskier
Since the risks of investments cannot be eliminated totally, the best means is to pick
investments that have more likelihood of changing value at different times in different ways in
the process of diversification: to take the advantage of the difference in risks among different
investments (Frey, Frey, & Bytes, 2012). This is because investments change in value in different
directions and at different times. Therefore, with such a portfolio, if only one investment losses,
the portfolio will only lose a small portion of the value than it could happen to a single
investment. An example is a process of holding two investments which exactly change in
opposite directions. If one of them reduces by 1 percent, the other one will increase by1 percent.
Any change results in not only zero risk but also zero gain.
Formulate an argument for investment diversification in an investor portfolio.
Many companies adopt diversification for many reasons. It acts as a survival strategy
when a single service or product reach the limit of revenue generation (Swensen, 2011).The
diversification is usually driven by different factors such as possible opportunities within the
environment of the business, availability of the necessary resources and ownership of the right

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sets of skills to make the necessary adjustments. When some assets reduce in value, others
should be in a position to appreciate, portfolio diversification reduces the long terms risks.For
example if a person buys a share of stock for $40 and the re-sells it at $30, he makes a loss. An
alternative is to have two shares of stock: he purchases one stock at $40 and sells it at $30,
making a loss of $10.The other stock is purchased at $20 and sold at $50 and, therefore, making
a return of 30. In such an example, the risk of getting a loss is eliminated through diversification.
Diversification results to higher returns. In addition, it helps a person to adjust investment
matrices (Graham, Zweig, & Buffett, 2006).
However, even though diversification is a great tool for dealing with investment
uncertainties, some people over-complicate things if they have several investment strategies.
This raises some disadvantages. One of the cons of the portfolio diversification is that it reduces
quality. A lot of stocks put in portfolio reduce the concentration of the portfolio towards the best
opportunities. In addition, diversification increases complexities. An investor may include a lot
of assets in the portfolio such that he fails finally fails to understand what is entailed on them
(Kaunas, 2010). Diversification makes the investment to approach some other bad vehicles of
investments. Most of the investors who enter into over-diversification end up using some
investment vehicles such as traded mutual funds or index funds. Based on financial research,
these types of funds finally flounder in the market indices
Address how stocks, bonds, real estate, metals, and global funds may be used in a
diversified portfolio. Provide evidence in support of your argument
In each of the above assets, the investments do different things, the stocks help in the
growth of the portfolio while the bonds are used to bring the income. The real estate is used to
provide both a low correlation to stocks and a hedge against the inflation (Graham, Zweig, &
Buffett, 2006).In other words, it may increase when there is a fall in the stocks. Finally, the
global funds are used to maintain the buying power as well as providing growth in an

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increasingly global world.In addition; the cash offers stability and security in the portfolio.
Diversification is something that almost every investor wants, but it looks very hard to get if
there are no enough money for spending (Graham, Zweig, & Buffett, 2006).Fortunately, there are
many options available for the investors. The best means for investors to allow diversification is
buying more stocks and looking for more funds. Through the allocation of few slots in portfolio
by use of other classes of assets (such as bonds, real estate, hard assets.), many other styles as
well as other regions, investors can realize remarkable levels of diversification without stretching
too far on their capital. However, due diligence should be given to all other assets and not
diversifying for the sake of diversification.
Evaluate the concept of the efficient frontier
The efficient frontier is a model of modern portfolio theory consisting of a set of the
portfolio. Every portfolio has a feature that there is no other portfolio existing and having a
greater expected return but the similar return of standard deviation. The portfolio is referred as
efficient if it has the best return level for its risks. Efficient Frontier aims at investors who are
accustomed to the basics of the portfolio and finance theory: a set of optimal portfolios offering
the largest expected returns for defined levels of risks or the lowest risks for given levels of
expected returns. Analysis of the efficient frontier tries to theoretically identify the best
diversification levels. Portfolios lying below the efficient frontier are regarded as sub-optimal
since they dont provide enough returns for the levels of risks (Reilly & Brown, 2012). In
addition the portfolios clustering to the right side of the efficient frontier are also sub-optimal
because they have higher levels of risks for the defined rates of return. The efficient frontier
refers to the line on a risk-reward graph constituting all the efficient portfolios of investments:
portfolios providing the highest expected returns for given levels of risk or the ones having the
least volatilities.
How to use portfolio to determine an asset portfolio for a specified investor

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The most crucial factor which affects the portfolio returns is not the allocation of the
assets but the quality of the investments (Swensen, 2011).This is whereby the allocation of assets
is done in different areas of the portfolio for the purpose of ensuring that its capital has been
diversified in a way of targeting above average rates of return. Mostly an investor selects and
investment by focusing on the expected returns or the past experiences. The process of the
portfolio optimization is very complex computation procedure but those who do it get the
rewards for it. The efficient frontier brings in some other aspects of the quality of investment for
an investor: the risk volatilities and relationships of the return with different investments
(Graham, Zweig, & Buffett, 2006). This makes sure that after the formation of the portfolio,
there is a maximization of the investors tolerance for volatility. Returns above the median are
targeted at the expense of the investors who are less sophisticated and whose portfolio lies below
the efficient frontier. For a given investor, all combinations of assets that are risky are plotted,
and the collection of the portfolios defines regions within this space. If there are no opportunities
to hold assets that are risk-free, such a region is defined as the feasible set (opportunity set)
Consider the economic outlook for the next year in order to recommend the ideal portfolio
to maximize the rate of return for the short term and long term.
Economic outlook
The fundamentals which underpin the economy of the United States continue to improve,
and the monetary policy is deemed to gain an extra traction. However, this may lead to a stronger
growth due to the recent increase in the economic restraint. As a result, it will be very crucial for
the monetary policies to remain very accommodative. The first thing is that there is welldeveloped household deleveraging. Debts based on households have significantly declined as
compared to the income. Similarly, the obligation ration of the households finance has
decreased. Third, the global economic outlook has improved to a certain degree. The strains of
the international financial markets have also receded. The third aspect is that relative corporate

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profits and cash balances remain very high.Therefore, as outlook improves and uncertainty
declines, the business is expected to shift towards real investment mainly from hoarding cash and
buying shares back. Looking at this years outlook, it is expected that next years growth will be
sluggish in the first quarter as the economy is blunted by the fiscal contraction. Based on the
above outlook, the best means to maximize the returns will be to use the conservative model
portfolio which will lead to the allocation of larger percentages of the total portfolios in a way of
lowering risks security such as money market and fixed income security. Moreover, while United
States should increase the public finance on a proper foothold, it should be done in a manner that
will best achieve both long-term and short-term objectives.
Explain the key differences between the short and long term.
Short-term bonds are less sensitive to fluctuations in the rates of interest and have short
durations than the long-term bonds. Bonds can be bought and mature within very few days rather
than long-term bonds which may take some time (Graham, Zweig, & Buffett, 2006). This
therefore means that in the case of the rise in the level of interest rates, bonds having longer
maturity are sheltered at low rates.

References
Frey, A. H., Frey, A., & Bytes, I. (2012). A Beginner's Guide to Investing: How to Grow Your
Money the Smart and Easy Way (3rd ed.). CreateSpace Independent Publishing Platform.

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Graham, B., Zweig, J., & Buffett, W. E. (2006). The Intelligent Investor: The Definitive Book on
Value Investing. A Book of Practical Counsel (1st ed.). HarperBusiness.
Kaunas, L. (2010). Investment Analysis and Portfolio Management. Retrieved from:
http://www.bcci.bg/projects/latvia/pdf/8_IAPM_final.pdf.
Reilly, F. K., & Brown, K. C. (2012). Investment Analysis & Investment Analysis & (10th ed.).
Retrieved from :http://www.cengagebrain.co.nz/content/9781133792598.pdf.
Swensen, D. F. (2011). Pioneering Portfolio Management: An Unconventional Approach to
Institutional Investment (5th ed.). Free Press.