Chapter 13: Portfolio Optimisation

The term portfolio refers to a collection of financial assets such as stocks, bonds and options. An entity may spread its investment across the various assets in the portfolio. Each asset in the portfolio can potentially earn a return, and there is also the potential risk of running a loss. The returns of all the assets in a portfolio determine the overall return of the portfolio as also the risks of the individual assets determine the overall risk of the portfolio. So, a portfolio can potentially earn a return and also has an associated risk of making a loss.

Diversification of risk is a basic motivation for constructing a portfolio. By spreading an investment across a number of financial assets, an entity tries to ensure that a loss in any one asset can be offset by profit from some other asset. Broadly speaking, the goal of portfolio optimisation is essentially to maximise the expected return and minimise the risk. Simultaneously achieving both can be difficult.