| Course | INV-7110 Investments |
|---|---|
| Module | Module 2 |
| Paper type | Module 2 written assignment: portfolio theory, pricing models and statement analysis |
| Length | About 599 words, 5 pages |
| Format | APA 7 student paper |
| School | Thomas Edison State University |
| Program | Master of Business Administration |
| Updated | October 2026 |
Free sample paper for INV 7110 Module 2
Why Diversification Works and What a Stock Should Earn: Portfolio Theory and Pricing Models
Student Name
Master of Business Administration, Thomas Edison State University
INV-7110: Investments
Mentor Name
Month Day, Year
Why Diversification Works and What a Stock Should Earn: Portfolio Theory and Pricing Models
Introduction
The Mercers, the composite couple from Module 1, want to know why their adviser recommends holding bonds that earn less than stocks, and whether a specialty chemicals stock their neighbor recommends is worth buying. Both questions turn on investment theory. The first answer rests on Markowitz (1952): mixing assets that do not move in step cuts risk by more than it cuts return. The second question also needs financial statements, since a recommendation from a neighbor is only a starting point; the paper therefore closes by comparing the company's ratios with its industry.
Two-Asset Portfolio Risk
At a 0.2 correlation, the 60/40 mix should return 7.2 percent, simply the weighted average. Its variance equals 0.36 times 0.0324, plus 0.16 times 0.0036, plus 2 times 0.6 times 0.4 times 0.2 times 0.18 times 0.06, which totals 0.01328, a standard deviation of about 11.5 percent. That is well below the 13.2 percent weighted average of the two standard deviations. The lower the correlation, the larger the reduction; at a correlation of 1 there would be none. Repeating the calculation for every mix traces the efficient frontier, and the Mercers' allocation should lie on it.
| Fund | Expected return | Standard deviation |
|---|---|---|
| Stock fund | 9.0% | 18% |
| Bond fund | 4.5% | 6% |
Required Returns
The specialty chemicals company has a beta of 1.15. With the chemicals maker's beta of 1.15, a 4.2 percent Treasury rate and a 5.5 percent premium, the CAPM asks for about 10.5 percent. Fama and French (1993) found that small companies and companies with high book-to-market ratios earned returns that beta alone did not explain, and proposed a three-factor model. The company is small, with a factor loading of 0.4 on size, and modestly value-oriented, with a loading of 0.3 on value. Using a market beta of 1.05 in the three-factor regression and premiums of 2 percent for size and 3 percent for value, its required return is 4.2 plus 5.8, plus 0.8, plus 0.9, about 11.7 percent. The two models disagree by more than a point, a reminder that required returns are estimates.
Market Efficiency
Fama (1970) called a market efficient when its prices fully reflect what is known, and sorted the tests into weak, semi-strong and strong forms. If the market is semi-strong efficient, the neighbor's tip, based on public information, is already in the price. So the Mercers should build around cheap index funds and buy a single stock only with a real reason to think the market has it wrong. Efficiency does not mean prices are always right, only that it is hard to profit from public information after costs, which is why the burden of proof falls on anyone recommending a single stock.
Financial Statement Analysis
The company earns more on equity than its peers with similar debt and trades at a slightly lower multiple. That combination may reflect risks the ratios do not show, such as dependence on one large customer, which the notes to the statements disclose. Module 3 values the shares in full.
| Measure | Company | Industry median |
|---|---|---|
| Return on equity | 14.0% | 12.5% |
| Net profit margin | 8.5% | 7.8% |
| Debt to equity | 0.65 | 0.70 |
| Interest coverage | 7.2 times | 6.0 times |
| Price to earnings | 13.0 times | 14.0 times |
Conclusion
Diversification lets the Mercers hold a 60/40 mix with risk of about 11.5 percent, well below the average of its parts. The chemicals stock requires a return of roughly 10.5 to 11.7 percent depending on the model, and its statements look solid. Whether its price is attractive requires the valuation in Module 3.
References
Fama, E. F. (1970). Efficient capital markets: A review of theory and empirical work. Journal of Finance, 25(2), 383-417. https://doi.org/10.2307/2325486
Fama, E. F., & French, K. R. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33(1), 3-56. https://doi.org/10.1016/0304-405X(93)90023-5
Markowitz, H. (1952). Portfolio selection. Journal of Finance, 7(1), 77-91. https://doi.org/10.2307/2975974
INV 7110 Module 2 instructions, in plain terms
The second INV-7110 written assignment covers developments in investment theory and the analysis of financial statements. Expect problems on portfolio risk and return, the efficient frontier, the capital asset pricing model, arbitrage pricing theory and multifactor models, market efficiency, and ratio analysis for investment decisions. Show the variance formula with its terms when computing portfolio risk. When using more than one pricing model, compare the results and explain the difference. Link financial statement ratios to valuation questions rather than presenting them alone. Some problems give historical returns and ask you to compute averages, standard deviations and correlations before building the portfolio, so set up your spreadsheet to do this step cleanly. State the source of any market data you use, such as a Treasury yield, and the date it was observed.
How this INV 7110 Module 2 example is built
The paper opens with two questions from the composite clients. The 60/40 section shows every term of the variance and why a low correlation pays. A required return section applies the CAPM and a three-factor model and explains why they differ. A market efficiency section relates the forms of efficiency to the clients' choices. A ratio table compares the company with its industry, and the text interprets what the ratios show and what they might hide. The conclusion sets up the valuation in Module 3. The calculations use round, plausible figures so that each step is easy to follow.
INV 7110 Module 2 rubric: what earns full marks
Mentors grade this assignment on correct portfolio and pricing calculations, accurate explanation of theory and sound interpretation of financial statements. Answers that show why portfolio risk falls below the weighted average, and that compare pricing models, show understanding beyond formulas. Applying market efficiency to a real decision demonstrates judgment. Ratios compared with a benchmark and interpreted for investment purposes earn more than ratios listed without comment. Citing the original research behind each theory strengthens the paper. Mentors look for precise language: systematic and unsystematic risk, beta and standard deviation, and the forms of efficiency each have exact meanings. Papers that note the limits of each model, such as the CAPM's single factor, show critical understanding. A conclusion that links theory back to the client's decisions completes the analysis and shows the purpose of the theory.
INV 7110 Module 2 help from the desk
Common slips: averaging the two standard deviations, running the CAPM with unstated inputs and defining efficiency without saying what it means for the investor. Use the full variance formula. Say where your riskless rate and market premium came from. Explain what each form of efficiency means for an investor's choices. Compare ratios with an industry benchmark and say what the comparison implies for the price. When models disagree, report both results and explain why rather than choosing the one that suits your conclusion. A free first sample on your own INV-7110 Module 2 problems is available on request.
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INV 7110 Module 2 questions, answered
Where can I find a free INV 7110 Module 2 sample paper?
Portfolio risk, CAPM and three-factor returns and market efficiency are applied above for the composite couple.
Why is portfolio risk lower than the weighted average of the assets' risks?
Because returns that are not perfectly correlated partly offset each other.
What does the Fama and French three-factor model add?
Factors for company size and book-to-market value, which explain returns beta alone does not.
What are the three forms of market efficiency?
Weak form reflects past prices, semi-strong form all public information and strong form all information, public and private.
How should ratios be used in investment analysis?
Compared with industry benchmarks and linked to valuation, to judge whether a price is justified.