In this chapter, you will learn about Modern Portfolio Theory (MPT) and its central components. We will look at the basic tenets of Modern Portfolio Theory, the Markowitz Efficient Frontier, the Capital Asset Pricing Model (CAPM), and the Efficient Market Hypothesis. We will also introduce you to various measures of portfolio variability – variance, covariance, standard deviation, and correlation coefficient. At the end of the chapter, you will be able to distinguish between hedge fund investing and the theoretical framework of Modern Portfolio Theory.

When you have completed this chapter, you should be able to:

• Describe the concepts of Modern Portfolio Theory (MPT) and the Efficient Market Hypothesis (EMH)

• Differentiate between variance, covariance, standard deviation, and correlation coefficient

• Calculate the standard deviation and expected return on a portfolio

• Explain how these measures are used in portfolio building

• Explain how these concepts relate to traditional investments and hedge funds