These are the points at which the indifference curves are tangent to the highest possible capital allocation line, i.e. These investors should make the investment up to point X and Y respectively.
Now suppose there are two investors one risk-averse and the other, a risk seeker, with their respective highest attainable indifference curves, IC 1 and IC 2. And despite, this point being unattainable, it can be attained through lending/borrowing.Į. Just like in the above figure, X and A have almost the same level of risks but X has a higher return. This is mainly because the line with the higher slope always has a point corresponding to the point on the lower line, with the same level of risk but a higher return. In a choice between the three allocation lines, it is best to choose the one with the highest slope (like CAL(C) in this case). And all these points are efficient portfolios on their respective minimum variance curves.ĭ. Though points B and C provide a better return in comparison to point A, it carries higher risk as well. To recall from the previous chapter, the equations of the capital allocation line is:Ĭ.
All these points lie on their respective Markowitz Efficient Frontier.ī. Points A, B, and C are the risk-return points if 100% allocation were made in the respective assets. CAL(A), CAL(B), and CAL(C) represent the capital allocation line for the three assets A, B, and C. LOS B requires us to: explain the capital allocation line (CAL) and the capital market line (CML)Ī. explain the selection of an optimal portfolio, given an investor’s utility (or risk aversion) and the capital allocation line. describe and interpret the minimum-variance and efficient frontiers of risky assets and the global minimum-variance portfolio describe the effect on a portfolio’s risk of investing in assets that are less than perfectly correlated calculate and interpret portfolio standard deviation explain risk aversion and its implications for portfolio selection į. calculate and interpret the mean, variance, and covariance (or correlation) of asset returns based on historical data Į. describe characteristics of the major asset classes that investors consider in forming portfolios ĭ. compare the money-weighted and time-weighted rates of return and evaluate the performance of portfolios based on these measures Ĭ. calculate and interpret major return measures and describe their appropriate uses ī. After reading this chapter, a student shall be able to:Ī. This topic is covered in study session 18 of the material provided by the institute.
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