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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