Mean-Variance Analysis Essay Example | Topics and Well Written Essays - 1500 words

Mean-Variance Analysis - Essay ExampleThe applicatory applications of portfolio conjecture uprise in different segments of business enterprise and finance. This report seeks to explain the principles of diversification, and discuss some practical applications of portfolio theory in business and finance. Table of Contents Executive Summary 2 Table of Contents 3 presentment 4 Principles of Diversification 4 Application of Portfolio guess Mutual Funds 5 Application of Portfolio Theory Capital Allocation 7 Application of Portfolio Theory to Product Portfolio Decisions 8 Recommendations 10 Conclusion 10 References 11 Introduction Diversification is the premise that underlies portfolio theory (Markus, 2008). A portfolio is a combination of assets with a merge danger and return value expectation. Diversified portfolios ensure that loses are minimized if they occur (Hill, 2010). Mean-variance analysis helps conciliate the viability of an enthronisation portfolio through the analysi s of the portfolio risk. The theory relies on the use of portfolios variance by comparison how assets in the portfolio vary with regard to each other (Diether, 2010). Mean-variance analysis for a diversified portfolio measures the portfolios efficiency. The well-nigh efficient portfolio has the highest expected return for a certain sample deviation. Mean-variance analysis application in business and finance helps in making the optimum decisions about the riskiness of a portfolio. This report seeks to demonstrate the practical applications of mean-variance analysis in portfolio theory. Principles of Diversification One of the principles of diversification is the belief that the portfolio, as a whole, is more pregnant than the individual assets (Sumnicht, 2008). Secondly, investors are risk averse, and therefore entrust only invest in those portfolios which they belief will be adequately commensurate to their returns. Investment should be for the long term, probably up to ten ag e into the future (Sumnicht, 2008). Diversification presumes that markets are efficient, and will not have any unforeseen disruptions. Finally, each risk take aim bears its own unique optimal allocation with regard to asset class at which the portfolio bears supreme returns. Application of Portfolio Theory Mutual Funds Mutual finances are actively managed investment options in which investors pay investment companies to invest their money in stocks and pay a return on the same. The monetary analysts at the mutual fund companies make use of portfolio theory in calculating risks on their clients portfolios. The portfolio theory offers a robust and comprehensive model on which to calculate risk and make sound investment decisions from the results (Sumnicht, 2008). However, mutual funds offer a unique challenge to the effectiveness of the portfolio theory in that the final examination return faces significant distortions due to high fees, hidden costs, unpredictable taxes, and uncer tain stock investments (Rutner, 2004). A study part of the modern portfolio theory is the frontier curve. The frontier curve plots risk and return (FundsMover, 2012). According to the portfolio theory, the funds that lie on the curve form the maximum yield potential for a given level of risk, measured as standard deviation. The curve flattens as the return rises. The rate of return per risk decreases, and at some point the amount of risk an investor exposes himself/herself to increases considerably for a slight increase in the return. The standard deviation indicates the volatility of the mutual fund.