ABSTRACT
This chapter begins with the basic concepts of investing and then develops Markowitz's mean-variance quadratic programming model and its applications in selecting a diversified investment portfolio. It discusses extensions by William Sharpe, who developed a bi-criteria linear programming model for portfolio optimization. The investment securities can be broadly classified into three major categories as follows: cash, bonds, and stocks. The chapter describes each investment category in detail and how they stack up under the conflicting criteria of liquidity, return, and risk. A good investment strategy is basically a trade-off between return and risk. There are two conflicting objectives to the selection of the optimal portfolio. Objective 1 is to maximize the expected annual return of the portfolio. Objective 2 in the Markowitz's model is to minimize the variance of the portfolio return. There are two types of bonds, government bonds and corporate bonds. The chapter ends with a discussion of investing in bonds and prudent strategies for investing in general.
