Unformatted text preview: ds at 5% and invest the rest in A to attain a portfolio that lies on the dotted line.
Expected return L best CAL efficient frontier A 5.00% C 4.75% B Standard deviation of returns E.
i) It is obvious from the diagram below that it is not correct to select the optimal balanced portfolio from a set of balanced portfolios (such as B3 and B4) formed by combining the risk free asset with a randomly selected portfolio (such as P). Otherwise, the chosen OBP will not be efficient. The OBP must be selected (on the basis of utility) from the set of balanced portfolios (such as B1 and B2) formed by combining the risk free asset with the ORP. 3 Expected return CALORP CALP B1 rf B3 B2 efficient frontier P – A randomly selected portfolio B4 ORP – Optimal risky portfolio for any investor in the presence of a risky free asset Standard deviation of returns ii) The same procedure of locating the ORP before the OBP still apply even if the borrowing rate is different from the lending rate. Otherwise, investors will end up with an inefficient OBP as illustrated by the following diagrams. For those who lend, it is not correct to select the optimal balanced portfolio from the set of balanced portfolios lying on the capital allocation line between rf and P (such as B3) that are formed by combining risk free lending with the randomly selected portfolio P. The OBP must be chosen (on the basis of utility) from the set of balanced portfolios lying on the capital allocation line between rf and ORP (such as B1) that are formed by combining risk free lending with the ORP . Expected return B1 efficient frontier P – A randomly selected portfolio rf B3 ORP – Optimal risky portfolio corresponding to the lending rate Standard deviation of returns Similarly, for those who borrow, it is not correct to select the optimal balanced portfolio from the set of balanced portfolios lying on the capital allocation line beyond P (such as B4) that are formed by combining risk free borrowing with the randomly selected portfolio P. The OBP must be chosen (on the basis of utility) from the set of balanced portfolios lying on the capital allocation line bey...
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This note was uploaded on 10/29/2010 for the course FINS 2624 taught by Professor Hneryyip during the Three '10 term at University of New South Wales.
 Three '10
 HneryYip

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