Topic 1 Portfolio Theory

Question 1

Capital Allocation Line (CAL) Equation

Answer 1

E(r) = rf + [E(rm)-rf/σ] ×σ

Question 2

What is CAL

Answer 2

It is the line connecting the rf asset with the tangency portfolio (the most north-west point of the investment opp. set. The line with highest Sharpe ratio as a slope

This is the optimal portfolio.

maximum SR says the point (portfolio) tangent to its line has the most E(r) per unit of additional risk

Question 3

Expected return on a portfolio with a risk-free asset

Answer 3

E(R) = wE(R) + (1 − w)Rf

w is the fraction invested in the risky asset

Question 4

Expected return on a risky portfolio

Answer 4

E(R) = w1E(R1) + w2E(R2)…+ wnE(Rn)