This lesson examines the measurement of risk and return and introduces the core principles of Modern Portfolio Theory.

2.1 Risk and Return Analysis
Risk and return are the two dimensions of investment decisions. The California State University syllabus covers returns and risks from investing, including expected return, variance, covariance, and correlation . The Regent’s University module includes “Analysis of the benefit of diversification of holding a portfolio of assets” . Key concepts include:

• Total Risk: The standard deviation of returns.

• Systematic Risk: Market risk that cannot be diversified away.

• Unsystematic Risk: Company-specific risk that can be reduced through diversification .

2.2 Modern Portfolio Theory (MPT)
MPT is the foundation of portfolio construction. The Nipissing University syllabus covers “all aspects of portfolio management” including asset allocation and risk management . The University of Pittsburgh syllabus introduces “basic portfolio theory and its implications for diversification” . Key principles include:

• The Efficient Frontier: The set of portfolios that offer the highest expected return for a given level of risk.

• The Capital Market Line (CML): The line that represents the risk-return trade-off for efficient portfolios.

• Diversification: Combining assets to reduce unsystematic risk.