Date of Award

1983

Document Type

Thesis

Degree Name

Master of Art

Department

Business

First Advisor

Patrick Land

Second Advisor

Jan Kniffen

Abstract

The major concern in a financial transaction is to maximize profit while minimizing the possibilities of capital loss . The first step necessary to obtain either of these goals is to enhance the financial investor's knowledge of the industry and specific company's history, prospects, and management intentions for the future. Secondly, the present and future economic conditions should be analyzed and their effect on how the respective investment reacts in these types of environments should be determined. After this knowledge has been obtained the investor may have enough supportive information to quantify the components of risk and make his investment decision.

This one investment represents the investor's entire financial structure, which may conform exactly to the investor's intentions and satisfy his financial needs. However, if the investor misjudged the various financial or economic factors or if some traumatic incident focused on this one investment, the investor may sustain a substantial loss or his expected earnings may not materialize. If the investor were to invest in two separate investments the effects on the total investment would be reduced, for only a portion of his investment would be hurt by a misjudgment or an isolated problem. This concept would suggest that the greater the number of investments, the less the risk would be of an individual incident effecting the total investment. The risk that is being reduced is the unsystematic risk, which can be totally diversified away by the increase in the number of investments held. This reduction of risk is called the "Portfolio Effect".

The determination of which investments should be included into the portfolio should have the same quality of investigation that was previously mentioned for the purchase of an individual security. As a part of this investigational analysis, the respective investment candidates' historical activity should be measured and compared to its own average activity, to the activity of the other investments candidates or grouping of candidates, and to the activity of the entire market during the various stages of the economic cycle .

The relationships of these investments can be used to heighten the portfolio effect by offsetting the negative movement of the individual securities during these cycles. Since the movement of the investments can be offset, they may also be controlled. This concept, along with the use of trend analysis, should allow the maximization of yield, during the first stages of a recovery, and the minimization of loss, after the recovery has peaked by adjusting the portfolio's investment structure .

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