Discuss the implications of combining a risk-free asset with a portfolio of risky assets.

Expert Solution

Answer:-

IMPLICATIONS OF COMBINING A RISK FREE ASSET WITH A PORTFOLIO OF RISKY ASSETS.

Meaning of Risk Free Asset- It is a type of asset / financial Instrument which does not have any sort of risk of default in term of its maturity, volatility , fluctuation. examples of Risk free assets are Fixed Deposits with Banks, Goverment Bonds etc. A risk free asset has a Beta of 0 , which means it will not be affected by the market volatility.

On the Other Hand, Risky Asset is a one which has a Beta greater than 0 and which is affected by market volatility and sentiments.

IMPLICATIONS:-

This will be the best Portfolio in the world if we combine risky and risk free asset together. It will result in a neutral yield. The volatility of the risky asset will get neutralized by the neutrality of risk free asset.

In Fact, If someone is risk averse ( Who hates risk ) he should combined both the type of assets in his Portfolio.

And, If someone is Risk Lover ( Who loves risk ) he should invest in Risky assets Only.

Examples:

Risk free assets:- Fixed Deposit, Government bonds.

Risky Assets:- Equity shares, Corporate debts

jeff jeffy answered 2 years ago

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