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Unformatted text preview: CHAPTER 8 PORTFOLIO SELECTION AND ASSET ALLOCATION ANSWERS TO END-OF-CHAPTER QUESTIONS 8-1. The vertical axis of the Efficient Frontier is expected return. The horizontal axis is risk, as measured by standard deviation. 8-2. There are many portfolios on the Markowitz efficient frontier, depending on how precise one wishes to be. For example, an efficient frontier could be calculated using 1 percentage point intervals for expected return, or one-tenth of a percent intervals. Regardless, there are many portfolios on the efficient frontier. The Markowitz efficient set consists of those portfolios dominating the feasible set of portfolios that could be attained. It is described by a curve, as opposed to a straight line. 8-3. Rational investors seek efficient portfolios because these portfolios promise maximum expected return for a specified level of risk, or minimum risk for a specified expected return. 8-4. Using the Markowitz analysis, an investor would choose the portfolio on the efficient frontier that is tangent to his/her highest indifference curve. This would be the optimal portfolio for him/her. 8-5. An indifference curve describes investor preferences for risk and return. Each indifference curve represents all combinations of portfolios that are equally desirable to a particular investor given the return and risk involved. Thus, an investor's risk aversion would be reflected in his or her indifference curve....
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- Spring '11