Asset Demand Theory 7014b

Asset demand theory : The theory of asset demand states that there are 4 factors that influence the quantity demanded for an asset , holding all of the other factors constant:: 1. The quantity demanded of an asset is positively related to wealth. 2. The quantity demanded of an asset is positively related to its expected return relative to alternative assets. 3. The quantity demanded of an asset is negatively related to the risk of its returns relative to alternative assets. 4. The quantity demanded of an asset is positively related to its liquidity relative to alternative assets.

Capital Asset Pricing Model (CAPM): is an important tool used to analyze the relationship between risk and rates of return. The primary conclusion of the CAPM is this: The relevant risk of an individual stock is its contribution to the risk of a well-diversified portfolio. A stock might be quite risky if held by itself, but—since about half of its risk can be eliminated by diversification, the stock’s relevant risk is its contribution to the portfolio’s risk, which is much smaller than its stand-alone risk.

Portfolio theory A strategy for managing a portfolio of investments in order to minimize risk and maximize return by having a variety of types of investments An asset’s risk has two components:(1) diversifiable risk, which can be eliminated by diversification, and (2) market risk, which cannot be eliminated by diversification. This theory recommends that the risk of a particular stock should not be looked at on a standalone basis, but rather in relation to how that particular stock's price varies in relation to the variation in price of the market portfolio. The theory goes on to state that given an investor's preferred level of risk, a particular portfolio can be constructed that maximizes expected return for that level of risk.

Financial intermediaries also promote risk sharing by helping individuals to diversify and thereby lower the amount of risk to which they are exposed. Diversification entails investing in a collection

(portfolio) of assets whose returns do not always move together, with the result that overall risk is lower than for individual assets. Systematic and nonsystematic risk each have another feature that makes the distinction between these two types of risk important. Systematic risk is the part of an asset’s risk that cannot be eliminated by holding the asset as part of a diversified portfolio, whereas nonsystematic risk is the part of an asset’s risk that can be eliminated in a diversified portfolio. Understanding these features of systematic and nonsystematic risk leads to the following important conclusion: The risk of a welldiversified portfolio depends only on the systematic risk of the assets in the portfolio. Reference 

"The Economics of Money, Banking, and Financial Markets", By Frederick S. Mishkin, Seventh edition ( chapter 2 page 32, chapter 4 page 87 , chapter5 appendix 1 page 7)

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Financial management by MICHAEL C. EHRHARDT & EUGENE F. BRIGHAM thirteenth edition (chapter 6 page 238)

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http://www.qfinance.com/dictionary/portfolio-theory

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http://www.investorwords.com/3083/modern_portfolio_theory.html#ixzz1oSOr75Sn