Purchase Solution

Is a diversification strategy a way to improve expected return of a portfolio?

Not what you're looking for?

Ask Custom Question

Is a diversification strategy a good way to improve the EXPECTED RETURN of a portfolio?

Use reference to theory or articles

Give an example that proves the answer

Purchase this Solution

Solution Summary

The 925 word solution presents a good discussion about diversification in portfolios.

Solution Preview

Every asset class has a different investment purpose. The portfolio return is the sum of interest, dividends, and capital gains. The risk attached to a particular portfolio is the variation expressed as the standard deviation of returns of each asset class. Standard deviation is a statistical measure of the amount of variance of the return from the average at any one time. In 1952, Harry Markowitz developed his theory on portfolio diversification. Later, Bill Sharpe added work on the optimization of return and risk. The two men shared the Nobel Prize for Economics in 1990. Their work illustrates how diversification can reduce risk to acceptable levels, and increase returns over the long term.

Markowitz and Sharpe discovered that if a portfolio was diversified by asset class, then the overall return from the portfolio could be improved for a given risk tolerance. Diversification lowers the risk attached to a portfolio due to the fact that returns of the various asset classes are not totally correlated. A portfolio of securities has an expected return that is a proportional blend of the expected returns of the individual securities. Risk is the possibility of unexpected changes in return as measured by standard deviation. Risk is not a proportional blend, but rather is beneficially lower by different amounts based on asset mix, and the asset correlation.

When a portfolio contains one asset class, the risk of the portfolio is the risk of the ...

Solution provided by:
Education
  • BSc, Dokuz Eylul University
  • MBA, Texas A&M University-Kingsville
Recent Feedback
  • "Thanks"
  • "Thanks"
  • "This is a great help...Thank you"
  • "Thanks for the advice!"
  • "Oh my gosh u are awesome... A++"
Purchase this Solution


Free BrainMass Quizzes
Balance Sheet

The Fundamental Classified Balance Sheet. What to know to make it easy.

Business Processes

This quiz is intended to help business students better understand business processes, including those related to manufacturing and marketing. The questions focus on terms used to describe business processes and marketing activities.

Operations Management

This quiz tests a student's knowledge about Operations Management

Basic Social Media Concepts

The quiz will test your knowledge on basic social media concepts.

Situational Leadership

This quiz will help you better understand Situational Leadership and its theories.