or equivalently, the lowest risk for a given expected return is
called an
efficient portfolio
(3) The line representing all
efficient portfolio is called the
efficient frontier
(4)
Markowitz
efficient market frontier is not efficient once a risk-free asset
is available at which to lend or borrow
Efficient frontier of a 2 asset portfolio
Efficient set for many securities:
Given the opportunity set, we
can identify the minimum variance portfolio. The section of
the opportunity set above the minimum variance portfolio is
the efficient frontier.
Capital market line (CML) - also known as the new efficient
frontier:
If there is riskless borrowing and lending then we
draw the steepest line from the risk-free rate tangent to the
efficient frontier. Investors are able to allocate their money
across the risk-free asset and the market portfolio with
optimal result.
Both CML and SML contain only efficient portfolios.
The market portfolio:
(1) The market portfolio is the portfolio
at the tangent line of the risk free asset with the efficient
frontier of all risky assets available. (2) All risky assets are
included in this portfolio
in proportion to their market value
(3) Because it contains all the risky assets, it is a completely
diversified portfolio, which means that all the unsystematic
risk is diversified away (4) The market portfolio has a beta of 1
Efficient set for many securities with a risk free asset
Risk lovers
will pick a higher point on the CML (green x)
Risk adverse
people will pick a lower point on the CML (yellow
x)

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- Spring '11
- tohmunheng
- Capital Asset Pricing Model, Financial Markets, Investing, Modern portfolio theory