Question

Explain how an investor can use the separation theorem and utility theory to produce an efficient portfolio suitable for his/her level of risk tolerance.

Answer 1

Separation theorem can be used by various investors in generating optimal rate of return on their portfolio by focusing on generation of the highest present value of their overall total investment by investing into such assets which will be helpful in diversification of his overall risk and maximization of his overall return.

Separation theorem is always focusing investors that they will be always choosing to invest into the portfolios who are offering them with the highest expected rate of return and it focuses that investors are risk averse and individual assets are always divisible in nature.

The optimal combination of investors preference for Risk and return can be determined using the nature of the investor which is risk averse in nature and he will be looking for always maximizing his rate of return by selection of those portfolios which will be offering him with maximum expected rate of return.