Modern Portfolio Theory Quiz

The key insight of MPT is that an asset's risk and return should not be assessed by itself, but by how it contributes to a portfolio's overall risk and return. This is significant in investment analysis as it provides a formalized approach to maximizing expected return for a given level of risk.

Diversification in investing refers to owning different kinds of financial assets to reduce the overall risk of the portfolio. It is based on the idea that owning different types of assets is less risky than owning only one type, and it is a fundamental concept in risk management.

The mathematical framework used in MPT involves assembling a portfolio of assets to maximize the expected return for a given level of risk. It is based on the concept of mean-variance analysis and extends the idea of diversification in investing.

The variance of return (or its transformation, the standard deviation) is used as a measure of risk in MPT. It is preferred for assessing portfolio risk because it is tractable when assets are combined into portfolios. Often, the past variance of returns is used as a proxy for the future variance, but more sophisticated methods are also available.

Economist Harry Markowitz introduced MPT in a 1952 essay, formalizing the concept of diversification and the relationship between risk and return in a portfolio. He was later awarded a Nobel Memorial Prize in Economic Sciences for his contributions to the development of MPT.