Mastering Financial Modelling in Microsoft Excel 3rd edn, 3rd Edition

12

Portfolio analysis

Introduction

Formulas

Optimum portfolio

Summary

INTRODUCTION

This chapter and the next chapter model fundamental finance theories on diversification and the cost of capital. This chapter discusses diversification as encapsulated by portfolio theory developed by Harry Markowitz from his original 1952 paper (see the Bibliography and References). The theory seeks to answer how risk varies when you combine shares or other risky assets in a portfolio. Return alone is not a sufficient measure and you need to consider other variables. The important finance variables for shares are their return and volatility, the latter of which is measured by the standard deviation of the shares. A rational investor wants to earn as much ...