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Tuesday, 7 April 2015

INVESTMENT ANALYSIS - PAST QUESTION

INVESTMENT ANALYSIS

PAST QUESTION 

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QUESTION:
A portfolio which lies on the efficiency frontier is said to be “efficient”.  What does this mean? 

Distinguish between a feasible and an efficient portfolio.  Is an inefficient portfolio ever a feasible portfolio? 

ANSWER:
Efficient Portfolio – the risk awareness of investors would generally make them to opt for portfolios that offer the highest possible return for a given level of risk or the lowest possible degree of risk for a given level of return.  In an array of limitless securities, a portfolio with the highest expected return for a given level of risk or portfolio with lowest level of risk for a given level of expected return is said to dominate other portfolios.  And the portfolio with highest expected level of returns for a given level of risk is called an efficient portfolio.

The set of all possible portfolios in an array of myriad of securities is defined as attainable set.  Giving the full set of attainable combination of portfolios, efficient portfolios can be constructed thus;  the frontier formed by the set of efficient portfolios is called the efficient frontier. 

An efficient frontier is a portfolio of securities in which for a given return has the lowest expected risk and for given has the highest expected return.  Rational investors would always seek  a portfolio of securities that lies on the efficient frontier.  All other portfolios, which lies outside the efficient frontier, are inefficient portfolios, even though they may be attainable.

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