Question
In: Finance
Why do we want portfolios on efficient frontier (EF) rather than the portfolios on the lower...
Why do we want portfolios on efficient frontier (EF) rather than the portfolios on the lower part of the portfolio possibilities curve (PPC)?
Solutions
Expert Solution
We want to invest in such a way due to utility maximization approach.
Utility maximization approach:
1. Modern portfolio theory assumes that investors are
rational.
2. They want to maximize the utility of their portfolio.
3. According to modern portfolio theory utility is a positive
function of return and negative function of risk.
4. To calculate portfolio with maximum utility, we calculate the
coefficient of variation.
5. Coefficient of variation is standard deviation divided by the
return of the portfolio.
6. Lower the coefficient of variation, the better, the lower the
unit of risk per unit of return.
7. The portfolio with a lower coefficient of variation in the pool
of portfolio- lies on efficient Frontier.
8. So a portfolio on efficient Frontier gives the lowest amount of
risk per unit of return.
9. That's why we invest in the portfolio on efficient Frontier
rather than portfolio below the Efficient Frontier (inefficient
portfolio).
jeff jeffy answered 9 months agoRelated Solutions
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The line originating from the risk-free rate to tangentially
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Why do we measure temperatures at the evaporator rather than the suction pressure?
Why do we measure temperatures at the evaporator
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Which of the following portfolios would be off the efficient frontier? Expected Return Risk Portfolio A...
Which of the following portfolios would be off the efficient
frontier?
Expected Return Risk
Portfolio A 13% (er)17% (risk)
Portfolio B 12 (er) 18 (risk)
Portfolio C 18 (er) 30 (risk)
1.Which of the following portfolios can not be on the Markowitz efficient frontier? Portfolio Expected Return...
1.Which of the following portfolios can not be on the Markowitz
efficient frontier?
Portfolio Expected Return Standard Deviation
Q 15% 22.5%
R 15.75% 24.75%
S 17.25% 27.75%
T 18.75% 30%
2.You need to invest $20M in two assets: a risk-free asset with
an expected return of 5% and a risky asset with an expected return
of 15% and a standard deviation of 45%. You face a cap of 35% on
the portfolio’s standard deviation. What is the...
Q1: what does the efficient frontier represents? Q2: how do we estimate the return and standard...
Q1: what does the efficient frontier represents?
Q2: how do we estimate the return and standard deviation of a
newly built portfolio from analyzing the stocks in that
portfolio?
Q3: in the regression equation, what is meant by a regression
that has an R-square with 0.95 and how does it compare with a
regression with a R-square of 0.30?
Q4: why do we use adjusted beta?
Q5: what is the information ratio and why do we use it?
Q1: what does the efficient frontier represents? Q2: how do we estimate the return and standard...
Q1: what does the efficient frontier represents?
Q2: how do we estimate the return and standard deviation of a
newly built portfolio from analyzing the stocks in that
portfolio?
Q3: in the regression equation, what is meant by a regression
that has an R-square with 0.95 and how does it compare with a
regression with a R-square of 0.30?
Q4: why do we use adjusted beta?
Q5: what is the information ratio and why do we use it?
a.) Why do we focus on maximizing the shareholder wealth rather than short- term profit maximization?...
a.) Why do we focus on maximizing the shareholder wealth rather
than short- term profit maximization?
b.) What is the difference between maximize the EPS (earnings
per share) and maximize stock price?
c.)What is the agency conflict between manager and shareholder
and how can we reduce this agency conflict?
Assume that investors want to invest in the most efficient (aka optimal) portfolios. The existence of...
Assume that investors want to invest in the most efficient (aka
optimal) portfolios. The existence of a risk-less security in the
risk & return trade-off:
does not influence investors preferences
regarding which risky portfolio to hold.
Results in investors all holding different portfolios of
risky assets depending on their individual risk
preferences
Results in investors all holding the same portfolio of
risky assets which corresponds to the tangency point of
the efficient portfolio frontier of risky assets and a line...
Why do we focus on maximize the shareholder wealth rather than short- term profit maximization? What...
Why do we focus on maximize the shareholder wealth rather than
short- term profit maximization? What is the difference between
maximize the EPS (earnings per share) and maximize stock price?
Also we can discuss about the agency conflict between manager and
shareholder and how to reduce this agency conflict.
explain what an efficient frontier is? do you think that the shape and the position of...
explain what an efficient frontier is? do you think
that the shape and the position of the frontier would be very
different had we used monthly returns instead of annualized
returns?
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