Portfolio Theory and Banks :: Finance Financial Essays

Portfolio Theory and Banks all over the years competition in the financial industry has been in truth high. Banks take up been competing harder over securities industry shares and profits. These firms have of late been facing a very unique challenge how to extract high levels of profit while stillness maintaining their foundations as lending institutions. Lending is not a very paid byplay, the bump of default coupled with the competition driving down market prices have made lending a less attractive enterprise. and so some banks are trying to concentrate on their more utile activities (i.e. advisories, debt and equity sales, mergers and acquisitions). But to be able to extract this sort of railway line requires banks to engage in loans. Without loans customers have no incentive to do business with them, since one of their primary needs is to finance their commercial activities through debt. Portfolio affirmableness gives these lending institutions a tool to minimi ze the risks and hazards of lending. Portfolio theory was first publish by Fischer shocking and Myron Scholes in 1973. This sit down provided banks with a strategy on how to diversify their loans and investments. Before this, banks had no real investment strategy and their besides option was to obtain as much collateral as possible and make default an unattractive option. Portfolio Theory allows companies or investors to diversify their investment so to minimize risk and maximize gain. The principle behind the Black Scholes feign is to diversify your equity so that your lowest risk alinement produces the same risk as your highest risk investment. When your investments have reached this equilibrium, then risk minimization has been achieved.1 1 www.kmv.com/Knowledge_Base/public/general/white/Portfolio_Management_of_default_Risk.pdf What is the Black - Scholes model? The model also called portfolio theory works under the following assumptions 1) Price of the underlier is lognormally distributed 2) No transaction costs 3) Markets trade continuously 4) Risk-free rate is unending and the same for all maturities.1 The model was first used for simple ordain and call options and now has been expanded for use with other financial instruments. This model is a mathematical model and certain variables are needed for the manifestation to work. These variables are the stock price, exercise price, time to maturity, volatility, and price of a give the sack bond that matures when the option does.