Question

Alice Minks is a high net worth investor who owns a well-diversified portfolio of fixed income securities. Minks hopes to use part of the future value of her portfolio to purchase a beach house in five years. Minks forecasts the future value of each security in her portfolio based on expectations of interest rate movements, government actions, and security analysis. Which decision is most consistent with modern portfolio theory?

A		Minks chooses her ten securities based on expected utility maximization.
B		Minks invests in several bonds issued by real estate firms with properties located along the coastline.
C		Minks expects to make no changes to her portfolio over her investment horizon because she believes she has performed sufficient research.
D		Minks restricted her portfolio to only investment graded bonds because of previous losses in speculative graded bonds.

Answer 1

Option C is Correct. In Modern Portfolio Theory (MPT) the main focus is on minimizing market risk while maximizing returns. The core idea states that an investor can create a well-diversified portfolio with multiple assets so that the individual security risks are diversified such that the portfolio earns maximum potential return while minimizing risks

Therefore, Minks should not make changes to her current well-diversified portfolio, as it is consistent with the concept of the MPT.

Option A is Incorrect as it implies about Expected Utility Theory not MPT.

Option B is Incorrect as getting exposure in real estate firms located along the coastline will concentrate the risk instead of diversifying it.

Option D is Incorrect because by restricting her portfolio to only investment graded bonds due to past losses in speculative graded bonds, Minks is showcasing behavioral bias of risk aversion due to recent losses and inconsequence concentrating her portfolio rather than well diversifying it with more risk and rewarding investments.