Modern Portfolio Theory

Understanding Modern Portfolio Theory

The Modern Portfolio Theory (MPT) is a practical method for selecting investments in order to maximize the return of a portfolio, within an acceptable amount of risk. A key component of MPT is diversification. 

MPT suggests that investors can achieve their best results by combining low-risk, low-return investments with high-risk, high-return investments. They could then calculate an optimal portfolio.  

MPT assumes that investors are risk-averse and that they intend to get the maximum return possible, for the least amount of risk. The aim of MPT is to achieve a certain return for the lowest possible level of risk. 

MPT doesn’t look at individual stocks, focusing on the profile of a whole portfolio instead. MPT essentially calculates a weighted average return of a portfolio, along with the weighted average level of risk. 

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