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Portfolio Theory and Investment Analysis - Essay Example
This paper acts as a briefing paper on three issues related to the portfolio investments of a UK charity, details of which are contained in the assignment brief: (1) diversification and the stock composition of the investment portfolio; (2) international investments; and (3) derivatives.
A good investment strategy is one that earns the investor an expected return that is at least equal to or higher than what comparable investments would earn (Sharpe, 1991).
The goal of any investment strategy is to maximise the value of the investment by getting the highest possible expected return for a given level of risk. Every investment involves risk, which is the possibility of losing money if the investment decision turns out to be a wrong one. According to normal human behaviour, the higher the risk, the higher should be the expected return. Different investments have different levels of risk. For the UK charity, the safest investment, which also gives the lowest return, is to buy UK government bonds because the government always pays its debt obligations. Other investments, such as metals, a start-up business, or equities have higher levels of risk, and according to studies such as one by Barclays (2007), equities have consistently given higher returns compared to bonds or metals. Thus, investing in equities is a good first step in the investment strategy. The next question is to choose which stocks to buy and how much of the fund would be spent for each stock. Answering these questions requires knowing how risk is measured and is affected by portfolio diversification.
The risk level ...