Chapter 10 - Portfolio management

Abstract

This chapter discusses the basic ideas of the portfolio selection. The chapter describes the combination of two risky assets and the combination of a risky asset and a risk-free asset. The chapter discusses two major portfolio management theories: the capital asset pricing model and arbitrage pricing theory. Optimal investing is an important real-life problem that is translated into elegant mathematical theories. In general, opportunities for investigation include different assets: equities (stocks), bonds, foreign currency, real estate, antique, and others. Portfolios that contain only financial assets are considered in this chapter. There is no single strategy for portfolio selection because there is always a trade-off between expected return on portfolio and risk of portfolio losses. Risk-free assets—such as the U.S. Treasury bills—guarantee some return, but it is generally believed that stocks provide higher returns in the long run. Portfolio selection has two major steps: the selection of a combination of risky and risk-free assets and the selection of risky assets. The chapter concludes with a discussion on several investment strategies that are based on exploring market arbitrage opportunities.