Question

1. Discuss when a company should consider Chapter 11 bankruptcy.
2. Can portfolio theory actually be applied by investors to improve their investment returns?
3. Since this is our last week for this course, discuss what you have learned and how it will help you in you future work.

Answer 1

1 A company should consider Chapter 11 bankruptcy only after all other possible avenues have been explored since this is the most complicated and expensive form of bankruptcy proceeding.

Usually, corporations who require time to restructure their debts opt to file this proceeding. The corporation can continue its operation after filing for bankruptcy but under careful supervision of the court. It offers debtors a fresh start provided the debtor fulfills all his obligations under the plan of reorganization. Many times, a corporation owns a business where the goodwill and intangible assets created hold far more value than the sum of its assets itself. In such a scenario, the corporation would like to stay afloat and restructure its business in order to get out of bankruptcy situation.

2. Portfolio theory hypothesizes that it is possible for investors to maximize returns by taking on a quantifiable amount of risk. Designing the optimal portfolio requires investors to reduce risk through diversification using a quantitative method. Even though modern portfolio theory makes a good point- keeping all your eggs in one basket is a bad idea- in the real world we seldom find market conditions that would enable designing the optimal portfolio. The theory requires the investors to be skilled in sophisticated portfolio management techniques in order to be able to take advantage of "perceived risky ventures" for long term benefits.

Another pressing concern is the optimal number of stocks required for diversification. How would investors find the number of stocks that eliminate all unsystematic risk? In practice, there is no quantifiable method to find the optimal number of stocks that would eliminate risk through diversification. Therefore, while MPT is an interesting theory which holds promise, it is hard to apply this theory in the real world while investing.