Portfolio Theory's Underpinning Principles Need to Be Uncovered before Assignment

Portfolio Theory's Underpinning Principles Need to Be Uncovered before Appreciating the Ceration of Capital Asset Pricing Model - Assignment Example The gain achieved from one asset can offset the loss incurred from the other only if both the assets are negatively correlated. In this project the basic principles of the portfolio theory or the portfolio management theory has been discussed along with the theoretical aspect of the portfolio management theory. The investment viability criteria have also been discussed along with the other basic conditions like risk and return which should be considered before making any investment. The need of diversification of the portfolio has also been discussed along with all the risks associated with the diversified portfolios. Principles of portfolio As per Lonestreth Bevis portfolio can be described as a mixture of investment which is held or will be held by the investor. This means a portfolio is a collection or a group of two or more assets or securities held by the investor to gain maximum return while setting off the risk associated with one stock with the return of the other. The invest ment portfolio is guided by a number of principles. The decision regarding the portfolio will comprise of the decisions regarding the securities held in that portfolio. If the investor is expecting more return then he have to bear more risk too. This means that high return comes with higher risk. The risk of the variability of a particular asset held in the portfolio depends on when the investor will liquidate or sell it. Diversifying the investment will lessen the risk associated with the portfolio. Therefore diversification will help to reduce of the variability of the return associated with the portfolio. The portfolio should be formed as per the need and the risk tolerance level of the investor (Periasamy, 2009, p.7.10). One of the important principles regarding the portfolio is efficient allocation of assets in the portfolio. Moist of the performance of the portfolio depends upon the correct allocation of securities in the portfolio. The securities which are to be included in t he portfolio the portfolio should be properly analysed in term of the expected return and risk associated with them and should be allocated in the portfolio according to the most appropriate weightage in order to achieve desired return from the portfolio. This could be done by analysing the historical prices and the performance of the portfolio (Ambrose wealth management, No Date, p.10). Theoretical background of portfolio management theory The portfolio management deals with the formation and performance of the portfolio. Theoretically the portfolio can be managed in five basic steps. The first step of managing the portfolio is to analyse the securities which are available for investment. This step includes accessing the various securities available to the investors. The securities which are available are analysed on the basis of the risk and return of those securities. The securities can range from the stocks to fixed deposits to risk free assts like treasury bills. The second ste p is to form different portfolios and analysing them. This is done by analysing