Surname 5
b. All –debt risky portfolio
0.153846154
c. All-equity portfolio
0.263157895
d. Optimal risky portfolio
0.297170074
The capital allocation line has a slope that defines the amount of gain gotten form a
minimal increase (1%) in risk. If the slope of the curve is established to be steep, then an
investor would expect a higher return given the higher risk of investment. Therefore the
capital allocation line with the highest value of slope (steepest) gives the highest expected
return from the portfolio. From the calculations above this is the optimal risk portfolio
(0.297170074).
The risky portfolio with the highest expected return does not give the highest return on its
own when combined with a risk-free asset. The all-equity risky portfolio above only yields
0.26 expected return which is lower than the optimal risky portfolio at 0.29. The CAL of the
optimal complete portfolio gives the highest expected return of 0.29% for every 1% increase
in risk, while the CAL of all debt-risky portfolio gives the lowest return (0.15%) for every
1% increase in risk.
In conclusion, calculating the slope of the CAL helps us to understand that diversification
of investment portfolios would bring some efficiency. At the minimum variance portfolio,
more return is gained from reduced risk. At any point above this more return is expected to be
earned for the increased risk. What it means is that if an investor wants to gain more returns
he/she has to take more risks.
Assuming two separate investors are looking to invest the same amount of cash into
their portfolio but have different risk aversions, say 5 and 7. The second investor is very risk-
averse. Risk aversion refers to how willing an investor is to take on a risky investment. In this
situation the yield is calculated as follows:
a. Minimum variance portfolio:
y =
= 0.052543679
b. All –debt risky portfolio
0.030769231
c. All-equity portfolio
