INVESTMENT ANALYSIS ASSIGNMENT

Investment Analysis Assignment

Investment Analysis Assignment

Introduction

Companies choose among investments often with the purpose of optimizing some goal and always limited by constraints. Assets are divided among competing investment alternatives with the hope that risk will be minimized for a desired level of return, either investment return or overall return. When the allocation fulfills the goals within the boundaries of constraints, it is thought to be efficient. The allocation is deemed to be a member of the efficient set at a point on an efficient frontier. It is efficient because it dominates off-frontier, interior points in the risk-return space. (Hubbard 2007)

Discussion

The Efficient Frontier Analysis story, though compelling, is absurd because the basis for Efficient Frontier Analysis and the proposed course of action it generates has absolutely nothing to do with the variables that determine investing outcomes. Worst of all, innocent, unsuspecting investors who have worked hard to accumulate capital respond to it.

Efficient Frontier Analysis

The Efficient Frontier is the line on a risk-reward graph comprised of all efficient investment portfolios; portfolios that provide the greatest expected return for a given level of risk or, for any expected return, the ones that will have the least volatility. (Chandra Shadel 2007)

All portfolios on the vertical dotted line above have the same risk. Of all the portfolios for a specific level of risk, such as the portfolio represented by the blue square at the intercept of the vertical and horizontal dotted blue lines, offers the greatest expected return for that level of investment risk; therefore, all portfolios for that level of investment risk that are below the blue square must be changed to the most efficient portfolio; the blue square, the Optimum Portfolio. (Chandra 2003)

The portfolio points on the illustration are determined by three factors while most often using historical information:

Expected Returns: The expected or average rate of return of an investment.

Volatility: The degree of random variability.

An investment that fluctuates widely over time has high volatility.

An investment that tends to be stable in price over time has low volatility. 

Correlation: The extent to which two investments tend to track one another.

Stock prices and bonds tend to go in the opposite direction. They are negatively correlated.

Auto parts stocks and auto stocks tend to go up and down together. They are positively correlated. 

Reduce risk and the possibility for return of a portfolio by investing in negatively correlated investments; both stocks and bonds.

Increase risk and the possibility for investment return by investing in positively correlated investments; auto parts and autos.

Yet, plastered on every investing document in the world the words, 'Past performance is not an indicator of future investment results,' which, as anyone who has spent more than a nanosecond in the financial markets would know, should know to be absolutely true. (Mandelbrot Hudson 2004)

This poorly misguided and misleading aspect of Modern Investment Theory has occurred because Ph.D.s have applied the science and certainty of mathematics to the artistry and chaos of the financial markets:

The development of Efficient Frontier analysis is based on easy to obtain historical data and ...