Corporate Investor Over the Last Several Years,

Corporate Investor

Over the last several years, the portfolio theory has been used as a way to help corporate investors analyze different securities and determine the impact of specific investments on their total returns. This is when a firm will construct a portfolio of securities which are based upon expected returns associated with certain levels of risk. During this process, there are four steps that are involved to include: security valuation, asset allocation, portfolio optimization and performance measurement. ("Modern Portfolio Theory," 2013)

These different areas reduce volatility and enhance the total returns for corporate investors. To fully understand these ideas requires: carefully examining the effects of the theory in relation to the risks of a security and the overall costs of capital to firms. Together, these elements will highlight why this approach has become so popular with corporate investors. ("Modern Portfolio Theory," 2013)

The effect of the portfolio on risk of a security

The portfolio theory is focused on risk and how much firms can avoid it. This means that they will select investments based upon the expected returns and underlying amounts of volatility associated with them. In these situations, there is a tradeoff between these two variables. As the greater returns will bring with it higher levels of risk. To reduce this, the portfolio theory calls for corporate investors to identify securities which can provide them with consistent returns. (Elton, 2009) (Francis, 2013) (Scherer, 2005)

This means that their performance may not be as high as others. However, the underlying amounts of risk are reduced. This allows them to provide consistent results in variety of market conditions. The effects on the portfolio, is that more stable returns will be realized over the long-term and investors can avoid the tremendous amounts of volatility. That comes with corrections and changes in the markets. (Elton, 2009) (Francis, 2013) (Scherer, 2005)

The effect of the portfolio on the overall cost of capital to the company

The effect that this will have on the cost of capital for firms is it will decrease. This is because these organizations are engaging in strategies that can provide more stable results and performance. For creditors and ratings agencies, these kinds of practices will give them greater amounts of confidence in the management's ability to deal with a variety of challenges. These views, will lead to lower interest rates for debt offerings in the public markets. This will have a positive impact on the costs of capital by illustrating how the firm is making prudent financial decisions. (Elton, 2009) (Francis, 2013) (Scherer, 2005)

Clearly, the reason why the portfolio theory has become so popular is because it provides corporate investors with a way of establishing predictable returns and reducing the underlying amounts of risk to the portfolio. This ensures that the management can select investments which will enable the firm to reach its established projections without having to worry about the impact of volatility on their bottom line results. (Elton, 2009) (Francis, 2013) (Scherer, 2005)