1

Introduction

Almost everyone owns a portfolio (group) of assets. This portfolio is likely to contain real assets, such as a car, a house, or a refrigerator, as well as financial assets, such as stocks and bonds. The composition of the portfolio may be the result of a series of haphazard and unrelated decisions, or it may be the result of deliberate planning. In this book we discuss the basic principles underlying rational portfolio choice and what this means for prices determined in the marketplace. We confine our attention to financial assets, although much of the analysis we develop is equally applicable to real assets.

An investor is faced with a choice from among an enormous number of assets. When one considers the number of possible assets and the various possible proportions in which each can be held, the decision process seems overwhelming. In the first part of this book we analyze how decision makers can structure their problems so that they are left with a manageable number of alternatives. Later sections of the book deal with rational choice among these alternatives, methods for implementing and controlling the decision process, and equilibrium conditions in the capital markets to which the previous analysis leads.

Let us examine the composition of this book in more detail.

OUTLINE OF THE BOOK

This book is divided into five parts. The first part provides background material on securities and financial markets. The reader already familiar with these topics can go directly ...

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