Question

Question # 3. Markowitz theory indicates to create and construct a portfolio of assets to maximize returns within a given level of risk, or to devise one with a desired, specified and expected level of return with the least amount of risk. Under this broader concept, answer the followings:

a) Justify, why an optimal portfolio should lie on security market line curve

b) Being an efficient market investor, justify how an efficient frontier curve can be helpful for you in portfolio selection process

Answer 1

Q:A; Why an Optimum Portfolio should lie on Security market line Curve?

Ans:- According to Markowitz Portfolio theory we can get desired level of expected return with laest or given level of risk. It can be maximised if it is put under some certain range of risk.

Optimum portfolio is that type of portfolio which matches the investors' preferrence with certain level of risk, its risk and reward characteristics signifies investor's utility function.

Security market line is the graphical presentation of capital asset pricing model that shows security's or stock's market risk plotted against expected return of entire market at any time.

It describes how an efficient portfolio can derive expected return with adjusted diverisfied risk or systematic risk.

SML helps to determine whether an investment in marketable security offer expected possible return with risk level or not. The security liying above or below the SML determine its expected return.

According to this above concept it is proved that optimum portfolio is that portfolio which lies on SML line and give optimum level of return from such diversified risk.

Q B: Being an efficient market investor, justify how an efficient frontier curve can be helpful for you in portfolio selection process .

Ans:- Efficient frontier is the set of portfolio that give highest possible reurn with low level of diversified risk in the market.

Ans the portfolio which gives maximum possible return with defined diversified risk is called as efficient or optimum portfolio.

Return is achieved when there is right combination of investments pool.The portfolio which has successful optimisation with return and risk is placed on a efficient frontier.

So from this it is justified that efficient frontier helps in optimum portfolio selection.