Question

5. Explain the Efficient Frontier of Risky Assets, Choosing the Optimal Risky Portfolio, and the Preferred Complete Portfolio and a Separation Property.

6. Explain the Single Index Model.

Answer 1

Efficient Frontier is a set of optimal portfolio which will be offering highest expected return for a defined level of risk and it is also defined at the lowest possible risk for predefined level of expected return so efficient Frontier will be used in order to make the optimal portfolio.

when we will be selecting the portfolio which is based upon the efficient Frontier then the portfolio will be lying below the efficient Frontier are suboptimal in nature, and Portfolio which are lying above the efficient Frontier are optimal in nature so they will be providing adequate return.

Choosing optimal risky portfolio is done on the middle of the curve and if one will going higher up the curve, it will mean that they are taking more risk proportionately for achieving lower incremental return so one will have to be at lower end of the curve in order to maintain the optimal portfolio.

preferred complete portfolio will be a Portfolio which will be providing with maximum rate of return and minimum level of risk so it will be reflecting on efficient Frontier and lying above efficient Frontier.

separation property is a important element in overall portfolio theory which is modern portfolio theory that will be giving a portfolio manager ability to separate the process of satisfying the client asset into 2 different parts and the two parts will be related to the market portfolio and the other part will be specific in nature will be related to the clients own portfolio.

6. Single index model is a simple asset pricing model which will be used for measuring both the risk as well as return of the stock and it is used in the the reference to the beta of the stock and Alpha also.

Single index model will be reflecting the stock return influenced by market beta and firm specific expected value and form specific unexpected component so the stock performance in relation with the market index is reflected by single index model.

Single index model will be only assuming that there is only systematic risk and that will be represented by the beta and it will be compared in relation to the market index.

this single index model will be representing the movement of the market which has been modified by the stock beta and it is also reflecting the unsystematic risk of the company

single index model advocates that the return of stock can be decomposed into expected excess return of an individual stock due to specific factor and return of Macro Economic events and unexpected micro economic events which will be affecting only the company.