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Unformatted text preview: e same rate. Consider an investor
who borrows and invests fraction of the funds in a portfolio of stocks and the rest in short-term
government bonds. In this case the investor can obtain an expected return from such an allocation along
the line from the risk free rate rf through the tangent portfolio in Figure 5. As lending is the opposite of
borrowing the line continues to the right of the tangent portfolio, where the investor is borrowing
additional funds to invest in the tangent portfolio. This line is known as the capital allocation line and
plots the expected return against risk (standard deviation).
Figure 5: Portfolio theory
Expected Return (%)
portfolio Risk free rate Standard Deviation The tangent portfolio is called the market portfolio. The market portfolio is the portfolio on the efficient
frontier with the highest Sharpe-ratio. Investors can therefore obtain the best possible risk return trade-off
by holding a mixture of the market portfolio and borrowing or lending. Thus, by combining a ris...
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This note was uploaded on 10/26/2012 for the course 19 19 taught by Professor - during the Spring '12 term at Sunway University College.
- Spring '12