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Personal Investment Management
ADMS 3531 - Fall 2011 – Professor Dale Domian
Lecture 1, Part 2 – Diversification and Asset Allocation – Sept 13
Chapter Two Outline
−Expected return and variances.
−Diversification and portfolio risk.
−Correlation and diversification.
−Markowitz efficient frontier.
−Asset allocation and security selection decisions of portfolio formation.
−In fact, diversification has a profound effect on portfolio return and portfolio risk.
Diversification and Asset Allocation
−Our goal in this chapter is to examine the role of diversification and asset allocation in
−In the early 1950s, Professor Harry Markowitz was the first to examine the role and
impact of diversification.
−Based on his work, we will see how diversification works, and we can be sure that we
have ‘efficiently diversified portfolios’.
oAn efficiently diversified portfolio is one that has the highest expected return,
given its risk.
oYou must be aware of the difference between historic return and expected return.
−Although it is important to be able to calculate historical returns, we really care about
expected returns, because we want to know how our portfolio will perform from today
−Expected return is the ‘weighted average’ return on a risky asset, from today to some
−To calculate an expected return, you must first:
oDecide on the number of possible economic scenarios that might occur.
oEstimate how well the security will perform in each scenario, and
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