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continued to discuss their differing opinions relative to investment
strategy, they began to get angry with each other. Neither was able to
convince the other that he was right. The level of their voices now
raised, they attracted the attention of the company’s vice president of
finance, Elinor Green, who was standing nearby. She came over and
indicated she had overheard their argument about investments and
thought that, given her expertise on financial matters, she might be
able to resolve their disagreement. She asked them to explain the crux
of their disagreement, and each reviewed his own viewpoint. After
hearing their views, Elinor responded, ―I have some good news and
some bad news for each of you. There is some validity to what each
of you says, but there also are some errors in each of your
explanations. Walt tends to support the traditional approach to
portfolio management. Shane’s views are more supportive of modern
portfolio theory.‖ Just then, the company president interrupted them,
needing to talk to Elinor immediately. Elinor apologized for having to
leave and offered to continue their discussion later that evening.
Questions a. Analyze Walt’s argument and explain why a mutual fund
investment may be overdiversified. Also explain why one does not
necessarily have to have hundreds of thousands of dollars to diversify
adequately. b. Analyze Shane’s argument and explain the major
error in his logic relative to the use of beta as a substitute for
diversification. Explain the key assumption underlying the use of beta
as a risk measure. c. Briefly describe the traditional approach to
portfolio management and relate it to the approaches supported by
Walt and Shane. d. Briefly describe modern portfolio theory and
relate it to the approaches supported by Walt and Shane. Be sure to
mention diversifiable risk, undiversifiable risk, and total risk, along
with the role of beta. e.
Explain how the traditional approach and
modern portfolio theory can be blended into an approach to portfolio
management that might prove useful to the individual investor. Relate
this to reconciling Walt’s and Shane’s differing points of view.