Finance Portfolio Management Coursework Example

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Date:Question One: The Traditional Approach to Portfolio Management
The traditional approach to portfolio management involves a non-quantitative way of balancing a portfolio with various assets such bonds and stocks from various companies and various sectors as a method of minimizing the overall risk. Based on the approach, diversification is the ideal way of risk management. The benefits of diversification rely on the correlations among classes of assets and not solely on their various standalone risks. A smaller risk may be realized by combining two assets since generally, the greater the correlation between two assets, the lower the risk reduction.
Question Two: The Error in Shane’s Logic
The beta measure tends to fluctuate rapidly over time considering the volatility of individual assets. The beta may be useful for investors who are want to invest in stocks, over a short period contrary to traders with long-term horizons. Shane claims that there is no difference in a single stock with a beta of 1.20 and a mutual fund with a beta of 1.20. However, the two portfolios might have the similar return, but a single stock is more likely to fluctuate compared to the mutual fund. For instance, a portfolio containing both G and F has the same return but less risk compared to individual assets since the fluctuations in asset G cancels out fluctuations in F. The combination of two assets is, therefore, less volatile compared to individual assets. The other error in Shane’s logic arises from the fact that beta is backward looking hence don’t capture the risk of a company which is different in future or today from the past.

In the event the profile of a company has changed, the risk implied in price today will be different from that of the past.