Question

• describe the effect on a portfolio’s risk of investing in assets that are less than perfectly correlated;

• explain the selection of an optimal risky portfolio and the capital allocation line (CAL);

• describe and interpret the minimum-variance frontier and efficient frontier of risky assets.

• explain the Separate Property.

Answer 1

1.Correlation refers to a statistical measure of the strength of the relationship between two variables. By combining securities that have a low correlation, the risk or standard deviation of the portfolio is reduced. It helps to diversify the risk of the portfolio.

The greatest benefits of diversification arise when two assets are perfectly negatively correlated. The profit in one asset offsets the loss in another asset here.                                                                                                              

We can eliminate all risk here.

2.A capital allocation line is created with all the possible combination of risk-free assets and risky assets. It displays the return to the investor undertaking a certain level of risk.

The efficient frontier shows investors the best possible return that they can expect from their portfolio given the level of risk they are willing to accept. The optimal portfolio will consist of a risk-free asset and an optimal risky asset. It is at the point where the CAL is tangent to the efficient frontier. The optimal portfolio does not just consist of high return or lowest risk securities. It balances securities with the highest return with an acceptable level of risk with lowest risks for a given potential return.

3.The portfolios that have the lowest standard deviation with a given expected return is known as minimum-variance portfolios. They make up the minimum-variance frontier.

The efficient frontier shows investors the best possible return that they can expect from their portfolio given the level of risk they are willing to accept. It is the basis of the modern portfolio theory. It consists of many securities, some which move in sync and some that move in the opposite direction. The lower the covariance of the securities, the lower will be the risk. It also represents the maximum level of return for its level of risk.

4.Separate Property

Separate property is any property before marriage or after divorce acquired as a gift or inheritance during marriage. Any income made by a spouse’s separate property during the marriage is considered the spouses’ separate property. An issue from property arises on the death of a spouse or divorce.

I hope that was helpful :)