Lecture 4

Question 1

How can we construct an Optimal Risky Portfolio?

Answer 1

Maximise Sharpe Ratio

Question 2

How can we construct an Optimal Complete Portfolio?

Answer 2

Maximise Investor’s Utility

Question 3

Capital Allocation Line

Answer 3

Line on which we can have all risk-return combinations in the risky portfolio and risk-free asset. Sharpe ratio is the slope

Question 4

Indifference curve

Answer 4

Every point on the indifference curve has an equal utility score. Steeper curve means that investors require a greater increase in expected returns to compensate for an increase in portfolio risk

Question 5

Markowitz Portfolio Optimisation Model

Answer 5

1. Identify right allocation of stocks to obtain Optimal Risky Portfolio with highest Sharpe ratio
2. Determine the right allocation of capital into the risk-free asset and the optimal risky portfolio, based on the degree of risk aversion of every individual investor. This maximises investor utility