Question

Suggest one way in which your Efficient frontiers could be made more efficient. What is the limitation of this suggestion?

Answer 1

Answer:

Efficient Frontier- It is a set of optimal portfolios that minimizes overall risk and maximizes return. It is the mix of portfolios that reap higher expected return at a lower level of risk. Portfolio is made with such a combination of assets/stocks that provide higher return and diversification reduces the risk.

To make the Efficient Frontier more effective- We can make our efficient frontier more effective by choosing the best blue chip stocks that have lower correlation. We should not put all our eggs in one basket that means, we should not invest into single stock or different stocks of same industry rather we should diversify our investment by choosing different stocks of different industries. There should be some defensive and some aggressive stocks, there should be some growth and income stocks so that portfolio can be balanced and if one or two sectors are not doing well that portfolio will not get affected much.

Limitation- In case of systematic risk, diversification does not work, systematic risk cannot be reduced through diversification. Systematic risk is the overall market risk that arises due to slow down in the economy or economic downturn. Sometimes there is a free fall market and all sectors come down due to panic selling pressure.