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Unformatted text preview: choose the portfolio of risky assets offering the highest reward to variability ratio. ORP is chosen by both the more or less risk averse. Their previously chosen portfolios of risky assets with the highest utility, i.e., ORPMRA and ORPLRA, are no longer efficient as they can now combine ORP and the risk free asset to form another portfolio that offers a higher level of expected return at the same level of risk. C. The reward to variability ratio is maximised by changing the composition of the risky portfolio subject to the constraints that the weights must add up to one and the individual weights must be greater than or equal to zero.
ORP when rf = 4.75%:
Portfolio Composition
S1 S2 L1 L2 E(RORP) σORP rf reward to variability ORP 0.7405 0.0000 0.0000 0.2595 5.3656% 3.4226% 4.75% 0.1799 D.
For those who lend risk free at 4.75%, their common optimal portfolio of risky assets has the following attributes:
Portfolio Composition
S1 S2 L1 L2 E(RORP) σORP rf reward to variability ORP 0.7405 0.0000 0.0000 0.2595 5.3656% 3.4226% 4.75% 0.1799 For those who borrow risk free at 5.00%, their common optimal portfolio of risky assets has the following attributes:
Portfolio Composition
S1 S2 L1 L2 E(RORP) σORP rf reward to variability ORP 0.1782 0.0000 0.0000 0.8218 5.5512% 4.7941% 5.00% 0.1150 2 For those who neither borrow nor lend, the range of portfolio weights in S1 and L2, expected return and standard deviation are:
Portfolio Composition
S1 S2 L1 L2 E(RORP) σORP ORP 0.1782 – 0.7405 0.0000 0.0000 0.2595 – 0.8218 5.5512%  5.3656% 3.4226%  4.7941% The following diagram summarises the ORPs for the three groups. • C is the ORP for those who lend. • A is the ORP for those who borrow. • For those who neither borrow nor lend, a range of ORPs lying between C and A are available and the one with the highest utility is chosen. • Note that the risk return combinations reflected by the dotted line are unattainable. For example, along the straight dotted line between 5% and A, investors cannot lend a portion of their fun...
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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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