“The benefits of diversification are clear. Portfolio theory has played a crucial role in explaining the relationship between risk and return when holding more than one investment. It also allows us to identify optimal and efficient portfolios. "With reference to this statement, describe, discuss, and illustrate the principles of portfolio theory. Your essay should include coverage of the Markowitz Efficient Frontier and the Capital Market Line. Statement: I confirm that this contribution is my own work. Vinita JavaIntroduction:An investor would invest in a stock for the return. However that return comes with a premium, risk The greater the risk an investor is willing to take, the higher the expected return is greater if you take high risks and vice versa risk is not only the possibility of capital loss but also the volatility of the return (http://www.fhmanning.co.uk/diversification.htm) Diversification: there is a saying famous "Never put all your eggs in one basket".' Although the benefits of diversification have been clear for a long time, they were not clearly exposed and quantified until Markowitz.HM Markowitz, in 1952, explained how an investor could achieve more from its investments. He suggested that the investor could achieve more efficient investment by holding a portfolio (combination) of stocks rather than investing completely in a single stock. He stated that when stocks are held together, the expected return of the portfolio would be a weighted average of the expected returns of each individual stock (J Ogilvie & B Koch 2002). The standard investment advice for all investors was to identify stocks that offered the best return. with the lowest risks and then create a portfolio...... middle of paper ......com/727/capital_market_line.html· FHManning, Diversification:http://www.fhmanning.co.uk/ diversification.htm · Moneychimp, Risk, http://www.moneychimp.com/articles/risk/riskintro.htm · ICI, Diversification, http://www.ici.org/i4s/bro_i4s_diversification.html · Risk Glossary, Market Risk, MPT, Risk Limits, Financial Risk Management · Modern Portfolio Theory and International Investment under the Uniform Prudent Investor Act , http://findarticles.com/p/articles/mi_qa3714/is_200101/ai_n8934269http://findarticles.com/p/articles/mi_qa3759 /is_200605/ai_n16629422 · Statman, M., How many stocks make up a diversified portfolio?, Journal of Financial and Quantitative Analysis, Vol 22, No.3, September 87. · Sendi, P., Marwenn, J. and Rutten, F ., 2004, "Portfolio theory and cost-effectiveness analysis: a further discussion", Value in Health, 2004, Vol 7, Number 5