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    Investment decisions of individual investors

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    1. This assignment is concerned with understanding of the key issues relative to portfolio analysis and investment. In completing this assignment you are to limit your scope to the US stock markets only. Use the the Internet, and other resources to write a 2-page essay which you will use with new clients of your financial planning business which addresses the following issues and/or practices:

    How individual investors make investment decisions in practice rather than in theory; and

    How investors manage their funds/savings/ investments in light of current stock markets.

    In your response, build upon extant portfolio theory and make sure to talk about different types of risks that investors might face and how they go about managing such risks. This means you need to consider topics such as efficient frontier and optimal portfolios; as well their relevance to investment theory. Furthermore, given the nature of the assignment, avoid bringing the brokerage industry into your discussion. In other words, assume you can invest directly in the stock market and do not need any financial intermediaries like brokerage houses.

    2. According to portfolio theory, people should hold more than one asset (or investment) in their portfolios. The idea is that if some investments do poorly, other investments in the portfolio can compensate for the poor investments. Some experts claim, however, that not all people in a society follow this prescription. In other words, not everyone will diversify and, in fact, many hold only one single asset or investment. For this you are to briefly address each of the following:

    Is such a claim true or false? Explain. (1 to 2 Paragraphs)

    Who, or what group(s), if any at all, might not want to spread his/her risks and diversify? Why or why not? (1 to 2 paragraphs)

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    Solution Preview

    1) How individual investors make investment decisions in practice rather than in theory; and
    How investors manage their funds/savings/ investments in light of current stock markets.

    According to portfolio theory an optimal portfolio and efficient frontier is described as a portfolio which provides an investor maximum return for a given level of risk or lowest risk for a desired level of return and an efficient frontier is a set of such portfolios. Several tools and techniques are available with professionals to identify such portfolios such as capital asset pricing model, beta, risk free and market rate of return, etc. But in reality, an average investor who invests himself and does not take any professional consultation chooses his investment picks and makes his decisions in a rather different manner. His decisions are more governed by different set of factors, other than the theoretical principles.

    In my opinion, stocks never trade on actual value. In fact, it trades on perceived value. The movements or sudden changes observed in stock prices are direct consequences of changes in perceptions of investors about a possible future event. This perception may be associated with a particular company, industry or the general business environment as a whole. History has proved that events like September 11 had drastic effects on the stock markets. These events cannot be compared to portfolio theories as these are outcomes of sudden changes in environment and no theory can describe these.

    An average or retail investor is the one which constitutes the largest base of investors in the market. Most of these ...

    Solution Summary

    How individual investors make investment decisions in practice rather than in theory is discussed in this solution, as well as what groups might not want to spread risks and diversify. The solution is about 1,000 words with references.

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