In this module, we will take you through a journey of imagining and visualising the relationship between risk and return, these quarrelsome and often misunderstood siblings of the investment world. You will see them in an entirely different light by the time you reach the end of this enlightening trip!

Here we discover the multi-faceted nature of this relationship through imagination, visualisation, simulation and analysis. We learn that risk and return are euphemisms for fear and greed – perhaps the most primordial of human sentiments – and that far from being a scary monster, risk is, in fact, the driver of return: “Without risk, there will be little or no return”, our resident Professor tells us! He also explains that risk is best viewed through a prism of statistics and event probability; as such, it can be visualised as a “range of probable return outcomes around an average value”.

Is the glass half full or half empty? That is the question! 

Understanding Risk Profiling examines the diversity of human perception and particularly the paradox that while the same investment may appeal to one investor it may be equally unattractive to another. Personal preferences play a key role in assessing investment prospects and must be superimposed on the already complex relationship between risk and return. 

This course probes this seemingly contradictory aspect of human nature through principles which were originally developed by the 18th Century Swiss mathematician and physicist Daniel Bernoulli using an imaginary game of chance he called the “Saint Petersburg Paradox”. You can play a similar game to find out your risk score and to discover whether your profile is what you thought it would be!

Understanding Diversification delves into the simple but wise age-old parable of not putting all one’s eggs in a basket. But are all eggs and all baskets created equal and how many eggs should we put in a basket anyway?

To explore and answer these questions, we will trace the steps of a mysterious medieval figure whose fortunes have finally taken a favourable turn and who now has a windfall to invest in the property market. We begin with the mathematics of a simple diversification strategy for our daring investor and progress to examine event probability using a game of dice, elaborating on the deeper nuances of diversification and their implications for modern-day portfolio construction and management.  

Understanding Asset Classes continues the theme of diversification by focusing on the building blocks of investing, namely the many types of “egg baskets” and their classification and characteristics. These include cash, stocks, bonds, property and commodities and more "exotic" and less tangible ones such as options and futures.

We focus on stocks & bonds and examines their behavioural traits, including historical risk and return profiles, factors which make them "tick", their sensitivity to market and economic events, and the unique "inverse" relationship between them which makes these instruments such amicable partners in the process of portfolio construction.

 We discover that far from being homogeneous groups, stocks and bonds come in many shades of grey and their spectrum of risk and return is wider and more diverse than could be imagined. We also put "property" under the microscope, following Signore Medici's own footsteps as he applies his tried and tested criteria to selecting an investment property to buy!

Understanding Portfolio Construction is the stage on which all the actors introduced in Modules 1-4 can interact and perform! In this gathering, risk and return take on new personas and asset classes begin to behave in a manner that is different to when they were in isolation: Normally rambunctious stocks can metamorphose and exert a moderating influence on the crowd while introverted bonds can emerge as the catalyst for many a convivial conversation.

We could say that asset classes are social animals and their personality transforms in a portfolio setting! If we are invited to this gathering, then our preferences as to which of these characters we wish to mingle with, in what combination and for how long will add yet another dimension to the complexity.

Modern Portfolio Theory (MPT) describes these transformations, interactions and permutations in the context of an investment portfolio. One peculiarity is that adding a risky asset to a portfolio could actually reduce overall risk, a phenomenon which for many may seem counter-intuitive.

Another key insight is that a portfolio containing two or more risky assets can be engineered in such a way as to maximise return for a given level of risk or minimise risk for a given level of return. There is only a finite set of portfolios which can be constructed in this fashion and collectively, these trace out a magical curve referred to as the Efficient Frontier.  Welcome to the alchemist's corner!

Understanding the Magic Black Box is a revealing glimpse into an essential tool of our study program: The silent engine which operates tirelessly behind the scenes, generating the dynamic numbers which allow us to create a lively variety of graphs, tables and diagrams for illustrating or elaborating key investment concepts and ideas.

Our Black Box is more than a mere curiosity, a mysterious automaton churning out numbers; that would be a simplistic characterisation of its invaluable contributions to this course. Indeed, we call it the "Magic" Black Box because of its diverse abilities and talents, from generating random numbers to support our visualisation efforts to performing simulations and producing probabilistic scenarios and forecasts. The Black Box is a versatile computational tool which helps us in our aim of demystifying a subject which for many is shrouded in mystery!