L6 - Portfolio Selection with Two Risky Assets

Question 1

What does the investment Opportunity Set look like?

Answer 1

• This is done by varying the weights we hold in the two assets

Question 2

What are the different terminologies we need to know for portfolio selection?

Answer 2

The investment opportunity set consists of all available risk-return combinations.

■ An efficient portfolio is a portfolio that has the highest possible expected return for a given standard deviation

■ The efficient frontier is the set of efficient portfolios. It is the upper portion of the minimum variance frontier starting at the minimum variance portfolio.

■ The minimum variance portfolio (mvp) is the portfolios that provide the lowest variance (standard deviation) among all possible portfolios of risky assets

Question 3

How can the investment opportunity set vary with different correlation values?

Answer 3

• Perfectly correlated –> no diversification benefits for holding the two assets

Question 4

Weight of portfolio if the correlation between two risky assets is -1?

Answer 4

w2 = sd1/(sd1+sd2)