The document discusses key aspects of portfolio theory and diversification. It explains how Harry Markowitz established that risk can be reduced by investing in multiple stocks instead of a single stock. The document also discusses how beta can be used to measure the systematic risk of a stock or portfolio in relation to the overall market. It further summarizes Sharpe's contributions, including how to simplify efficient portfolio calculations using the covariance matrix and defining beta. The capital asset pricing model is also introduced as a way to theoretically price assets based on their systematic risk.

2. MARKOWITZ' DEFINITION OF EFFICIENT PORTFOLIOS .

3. COMPUTATIONAL TECHNIQUES AND EXAMPLES.

4. THE DEFINITION OF BETA.

6. ICE CREAM, FOUNTAIN DRINKS AND POPCORN.

7. DURING THE WINTER WE WOULD SELL LOTS OF

8. COFFEE, HOT CHOCOLATE, HOT DOGS AND SANDWICHES.

9. WE COULDN'T RELY ON JUST ON PRODUCT TO STAY IN BUSINESS.

10. WE HAD TO HAVE BOTH A WARM AND COLD WEATHER MENU.

12. IT ESTABLISHED THE STATISTICAL MODEL THAT SHOWED

13. RISK IS REDUCED BY INVESTING IN MULTIPLE STOCKS INSTEAD OF JUST ONE STOCK.

14. IT LAID THE GROUND WORK TO CALCULATE EFFICIENT PORTFOLIOS USING LINEAR PROGRAMMING METHODS:

15. MAXIMIZE EARNINGS AT SPECIFIC RISK LEVEL

17. IF TWO EVENTS (a & b) ARE INDEPENDENT THAN THE TOTAL VARIANCE IS

18. VAR(a) +VAR(b).

19. IF TWO EVENTS (a & b) ARE NOT INDEPENDENT THAN THE TOTAL VARIANCE IS

20. VAR(a) +VAR(b) +2*COVARIANCE(a,b).

21. THIS FORMULA CAN BE EXTRAPOLATED TO MULTIPLE VARIABLES (STOCKS).

23. THEY RESPOND IN A SENSE TO SOME UNDERLYING MARKET WEATHER PATTERNS (NOT JUST THE ECONOMY).

24. A PORTFOLIO’S TOTAL VARIANCE INCLUDES COVARIANCE TERMS (MARKOWITZ CALLED THEM SEMI VARIANCE AT THE TIME).

25. ITS THE EXISTANCE OF COVARIANCE THAT ALLOWS THE DIVERSIFICATION OF PORTOLIOS DUR TO REDUCED TOTAL RISK

26. THIS DEPENDENCE AMONG STOCKS THAT MOVE TOGETHER IS A SEPARATE PHENOMENON FROM THAT IS DESCRIBED BY THE EFFICIENT MARKET HYPOTHESIS:

28. PORTFOLIO THEORY AND CAPITAL MARKETS.

29. THE FIRST CONTRIBUTION WAS TO SIMPLIFY THE COMPUTATION OF AN EFFICIENT PORTFOLIO BASED ON THE TWO MATHEMATICAL PROPERTIES:

30. AN EFFICIENT PORTFOLIO CAN BE COMPUTED AS THE MATRIX PRODUCT OF THE INVERSE OF THE STOCKS' COVARIANCE MATRIX AND THE VECTOR OF THE MEAN STOCK RETURNS MINUS A CONSTANT.

32. [MEANS-C]*[INVERSE MATRIX]

34. THIS PRODUCES TO EFFICIENT PORTFOLIOS WITH THEIR OWN

35. MEANS

36. VARIANCES

37. AND COVARIANCE

39. THE EFFICIENT FRONTIER WITH 20 STOCKS THE EFFICIENT FRONTIER WITH 20 STOCKS

40. THE EFFICIENT FRONTIER WITH 30 STOCKS

42. IT IS THE VOLITILITY OF THE STOCK TO MOVE WITH THE MARKET AS A WHOLE.

43. COVARIANCE(stock"a", MARKET)/VARIANCE(MARKET) OR BETA.

44. WHAT IS THE MARKET? THE S&P 500?

45. IF WE RUN A REGRESSION OF A STOCK'S PRICE HISTORY AGAINST THE PRICE HISTORY OF THE S&P 500 WE GET:

46. Y=A+B*X WHERE B IS THE BETA MEASURE.

47. HE ALSO SHOWED THAT THE BETAS ARE ADDITIVE

48. THE SUM OF THE INDIVIDUAL STOCK BETA'S ARE THE SAME OF THE PORTFOLIO'S BETA.

50. THE RATIONAL INVESTOR WILL PRICE ALL STOCKS SO THAT THEY WILL BECOME ONLY COMPONENTS OF EFFICIENT PORTFOLIO'S.

51. THERE IS NO PREMIUM FOR UNSYSTEMATIC RISK.

52. LETS TEST THE THEORY OF THE CAPITAL ASSET PRICING MODEL (CAPM).

55. BETA ISN'T PERFECT BUT YOU CAN ADD THEM TO ESTIMATE YOUR PORTFOLIO'S VOLATILITY.

56. THE HIGHER THE BETA THE WILDER THE RIDE.

57. CAPM AT THIS STAGE IS STILL JUST AN ECONOMIC EQUILIBRIUM MODEL.

58. THE SYSTEMATIC RISK OF THE MARKET WON'T GO AWAY SO BELLY UP TO THE TABLE AND PLACE YOUR BETS.