Question

Modern asset allocation is based upon the model developed by Harry Markowitz. Which of the following statements is/are correctly identified with the model?

1. The risk, return and covariance of assets are important input variables in creating portfolios.
2. Negatively correlated assets are necessary to reduce the risk or portfolios.
3. In creating a portfolio, diversifying across asset types (e.g., stocks and bonds) is less effective than diversifying within an asset type.
4. The efficient frontier is relatively insensitive to the input variable.

A. 1 and 2
B. 1, 2, and 3
C. 1 only
D. 2 and 4
E. 1, 2, and 4.

Answer 1

The accurate statements related to Harry Markowitz's model are that risk, return, and covariance are key inputs to portfolio construction and that negative asset correlation reduces risk, making option A (statements 1 and 2) correct.

Step-by-step explanation:

The correct statements associated with Harry Markowitz's model of modern asset allocation are that the risk, return, and covariance of assets are important input variables in creating portfolios and that negatively correlated assets are necessary to reduce the portfolio risk. Hence, the correct answer to the question is A. 1 and 2.

Concerning the statements given:

• Statement 3 is incorrect because diversifying across asset types can be more effective than diversifying within a single asset type, which helps in reducing unsystematic risk.
• Statement 4 is incorrect because the efficient frontier is sensitive to the input variables. Changes in expectations about returns, variances, and covariances of assets can change the composition of the efficient frontier.

Diversifying a portfolio is very important as it can help mitigate risks and improve returns. A diversified savings and investing portfolio doesn't guarantee economic success, but it increases the chances of more stable returns. Investors should consider the risk involved in different types of financial assets, and one way to manage risk is through diversification - meaning investing in a mix of assets such as stocks, bonds, and mutual funds to spread out exposure and potentially lower the impact of volatility.