optimal risky protfolios

Question 1

what do Portfolios of less than perfectly correlated assets always offer?

Answer 1

some degree of diversification benefit.

Question 2

What is an optimal risky portfolio?

Answer 2

Optimal Risky Portfolio
A risky portfolio is optimal when:
– It offers the highest reward to risk (or reward to volatility) ratio among the feasible portfolios.
–The Sharpe ratio is maximized

• Risk averse level does NOT matter for optimal risky portfolio construction. – Separation Property

Question 3

what is an Optimal complete portfolio

Answer 3

Optimal complete portfolio for an investor maximizes her utility level, however It depends on risk averse coefficient, A.

Question 4

describe the difference between optimal complete portfolio and optimal risky portfolio

Answer 4

Optimal complete portfolio reflects clients’ risk aversion level, but optimal risky portfolio does not.

Question 5

what do we assume in optimal capital allocation

Answer 5

In Capital Allocation, we implicitly assumed that the Asset Allocation is already done, and we are working with this optimal CAL.

Question 6

describe the steps for an optimal complete profile

Answer 6

1) Specify the return characteristics of all securities (expected returns, variances, covariances).

2) Establish the risky portfolio (asset allocation):
a. Calculate the optimal risky portfolio.
b. Calculate the properties of risky portfolio using the weights determined in step a.

3) Allocate funds between the risky portfolio and the risk- free asset (capital allocation):
a. Calculate the fraction of the complete portfolio allocated to risky portfolio and to risk-free asset.
b. Calculate the share of the complete portfolio invested in each risky asset and in risk free asset.