Portfolios • A portfolio is a collection of different securities such as stocks and bonds, that are combined and considered a single asset • The risk-return characteristics of the portfolio is demonstrably different than the characteristics of the assets that make up that portfolio, especially with regard to risk. • Combining different securities into portfolios is done to achieve diversification. | CHAPTER THREE INTRODUCTION TO PORTFOLIO THEORY 06 08 2011 1 Portfolios A portfolio is a collection of different securities such as stocks and bonds that are combined and considered a single asset The risk-return characteristics of the portfolio is demonstrably different than the characteristics of the assets that make up that portfolio especially with regard to risk. Combining different securities into portfolios is done to achieve diversification. 06 08 2011 8 -2 Diversification Diversification has two faces 1. Diversification results in an overall reduction in portfolio risk return volatility over time with little sacrifice in returns and 2. Diversification helps to immunize the portfolio from potentially catastrophic events such as the outright failure of one of the constituent investments. If only one investment is held and the issuing firm goes bankrupt the entire portfolio value and returns are lost. If a portfolio is made up of many different investments the outright failure of one is more than likely to be offset by gains on others helping to make the portfolio immune to such events. 06 08 2011 8 .
