This research will begin with the Decision Useful Approach. This approach motivates the application of decision models. The approach is based on the concept that if financial statements cannot be prepared correctly, then financial statements must be presented in such a manner so as to reflect useful information focusing on users and the decision problems that they face. The approach assumes that if the financial and accounting is useful to investors, then trading volume of stocks should experience a surge and securities prices are also expected to increase or respond in predictable manner relative to publicly available accounting information. The Single-Pearson decision theory aims to understand how an investor makes rational decisions under circumstances of certainty. The theory appreciates the concept of information and enables decision makers to keep informed and modernize their beliefs. The concept uses the publicly available financial statements as source of information. The rationale or principle of portfolio diversification is as follows:
Maintain a balance between risk and return
Assurance that the different securities held for investment are negatively correlated which will give an assurance of protection in case of any market shortfall and an expectation of positive returns.
Diversification of investment reduces the risk underlying the investment. Investment in a single stock of a particular company increases the substantial risk attached with the particular investment.
The Optimal Portfolio Investment
The concept of optimal investment falls under modern portfolio theory and assumes that investors prefer to minimize risk while striving for maximizing their expected returns.
(Source: Spreadsheetml.com, http://www.spreadsheetml.com/finance/freeportfoliooptimization.shtml, 2013)
The theory states investors will act rationally and thus they will always make decisions that will aim at maximizing their expected return for given tolerable level of risk.
It is one of the concepts used in risk-return analysis that gives an estimate of actual returns relative to expected returns of an investment. Important factors which are considered in measuring portfolio risks are standard