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Modern portfolio theory is a theory that helps us understand the nature of investment in an economy. It is a tool to analyze the relationship between an investor and the asset they are investing in.
The assumptions of modern portfolio theory are as follows:
- Investors hold diversified portfolios of investments, which can be categorized into three types: stocks, bonds, and cash.
- Investors have different risk tolerance levels and are willing to accept different levels of risk for their investments.
- The amount invested in each asset depends on its expected return and risk level.
- The returns from each investment are independent from one another.
Modern portfolio theory is a theory that emerged in the 1930s and has been used in the field of economics. It is a tool for assessing risk and return for investments. The theory has three basic assumptions:
- There are many investors with different levels of risk tolerance and returns.
- Investors have different time horizons and thus require different levels of return on their investments. Longer time horizons require higher returns than shorter ones.
- There is always uncertainty in the market, which means that there will always be some risk involved with any investment decision made
There are many assumptions on which the theory of modern portfolio is based. Some of them are:
Assumption 1: The idea of a portfolio is a new one
Assumption 2: A portfolio should be composed of different projects
Assumption 3: modern portfolio theory is that it can be used as a tool to evaluate the skills and competencies of an individual.
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