KIC000022 - Utility Maximization with a Risk-free Asset...

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Utility Maximization with a Risk-free Asset ~ Old Efficient Frontier Expected Return E(R.;) Std dev 0"; Portfolios on the Capital Market Line An investor holds a positive proportion of the two funds if the tangency between an indifference curve and the capital market line lies between the two funds • An investor borrows at the risk-free rate and invests in the market portfolio if the tangency between an indifference curve and the capital market line lies to the right of the two funds ~ Riskless Asset Old Efficient Frontier The Market Portfolio (with 2 risky assets) For two risky assets, we know that the portfolio return and standard deviation are given by Tobin's Two-Fund Separation When the riskfree asset is introduced, all investors prefer to move from their originally optimal portfolios to a combination of the riskfree asset and the market portfolio Alternatively stated, combinatjons of the riskfree asset and the market portfolio (JOm 1 r1 all other assets and portfolios
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KIC000022 - Utility Maximization with a Risk-free Asset...

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