Question

2. Discuss how the investor can use the separation theorem and utility theory to produce an efficient portfolio suitable for the investor's level of risk tolerance. 3. Two risky assets with returns r1, r2 and standard deviations 01, 02, and correlation p. Calculate the weights for the following two optimal portfolios. a. Minimum volatility (variance) portfolio minimizes the overall risk mino, s.t. W + W2 = 1 b. Maximum Sharpe Ratio portfolio delivers the highest expected return of unit of risk max-part w Op s.t. Wi+w2 = 1

Please solve question 2 and 3 below

Answer 1

The Investment Decision can be viewed as a top-down process:

1: Capital Allocation (How much money to invest in risk-free and risky assets)

2. Asset Allocation (Allocation of money into a series of risk-free and risky assets.

3. Security Selection: (Picking up securities into that asset class)

Hence, an investor can identify the optimum risky portfolio as the portfolio at the point of tangency between a ray extending from the risk-free rate and the efficient frontier of risky securities. Below the point of tangency on this ray from the risk-free rate, the efficient portfolios consist of both optimum risky portfolio and risk-free investments (T-bills); above the point of tangency, the efficient portfolios consist of the optimum risky portfolio purchased on margin. If the investor's indifference curve, which reflects that investor's preferences regarding risk and return, is superimposed on the ray from the risk-free rate, the resulting point of tangency represents the appropriate combination of the optimal risky portfolio and either risk-free assets or margin buying for that investor. Thus, the separation theorem separates investing and financing decisions. That is, all investors will invest in the same optimal risky portfolio and adjust the risk-level of the portfolio by either lending (investing in U.S. Treasuries, i.e., lending to the U.S.government) or borrowing (buying risky securities on margin).

Expected Return (%) 18 CAL(P) Indifference Curve Opportunity Set of Risky Assets Optimal Risky Portfolio Optimal Complete Portfolio 10 15 20 25 30 Standard Deviation (%)

PLEASE PROVIDE VALUES FOR Q2. IT'S INCOMPLETE