8.1 Modern Portfolio Theory
MPT underpins modern institutional asset management, demonstrating mathematically that asset allocation and diversification matter far more than individual security selection.
Key NASAA Exam Takeaways
- Modern Portfolio Theory (Harry Markowitz) demonstrates that combining non-correlated assets reduces portfolio variance without sacrificing expected return.
- The Efficient Frontier represents the set of optimal portfolios offering maximum expected return for a given level of risk.
- Systematic Risk (Market Risk) cannot be eliminated through diversification (Beta).
- Unsystematic Risk (Business/Credit Risk) CAN be eliminated through proper asset class diversification.
- Capital Market Line (CML) measures return against total risk; Security Market Line (SML) measures return against systematic risk (Beta).
Interactive Knowledge Checkpoint • Section 8.1
Under Modern Portfolio Theory (MPT), which category of risk can be effectively diversified away by holding a broad basket of 30 to 50 non-correlated stocks?