Chapter 6 - Portfolio theory

Question 1

What is an efficient portfolio?

Answer 1

A portfolio is efficient if the investor cannot find a better one in the sense that it has either a higher expected return and the same (or lower ) variance or lower variance and the same (or higher) expected return

Question 2

What is an efficient frontier?

Answer 2

is a set of efficient portfolios in the E-sigma space

Question 3

What do indifference curves represent in the mean-variance portfolio theory?

Answer 3

indifference curves join points (portfolios) of equal expected utility in the E-sigma space

Question 4

What is an opportunity set?

Answer 4

is the set of points (portfolios) in the E-sigma space that are attainable by the investor based on the available combinations of securities

Question 5

What are the assumptions under mean-variance portfolio theory?

Answer 5

• There are no transaction costs
• there are no taxes
• Any amount of assets can be held, i.e short selling is possible
• All expected returns, variances, covariances of pairs of assets are known
• investors choose portfolios based on expected return and variance of return only
• investors are non-satiated and risk-averse
• There is a fixed single-step time period

Question 6

What is an optimal portfolio?

Answer 6

is the portfolio that maximises the investor’s expected utility. it occurs where an indifference curve is tangential to the efficient frontier