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If portfolio ‘B’ shows more variability than Portfolio ‘A’ but has the same return, it will have a greater standard deviation with the same rate of return from the portfolio. Assuming the standard deviation for Portfolio B is 0.20, the equation would be read as (0.12 – 0.015) / 0.15. The Sharpe ratio for this portfolio will be 0.53, which is lower in comparison to Portfolio ‘A Course Description. $1,000 Duration: 4 weeks. In this asset and portfolio management course, you’ll learn key concepts and terms in the investment industry, such as efficient market hypothesis, frontier of risky assets, tangency portfolio, Sharpe ratio, and diversification. Markowitz Portfolio Theory. Harry Markowitz developed a theory, also known as Modern Portfolio Theory (MPT) according to which we can balance our investment by combining different securities, illustrating how well selected shares portfolio can result in maximum profit with minimum risk. He proved that investors who take a higher risk can also achieve higher profit. a single risky tangency portfolio, T. This key result is Tobin’s (1958) “separation theorem.” The punch line of the CAPM is now straightforward. With complete agreement about distributions of returns, all investors see the same opportunity set (Figure 1), and they combine the same risky tangency portfolio T with risk-free lending or borrowing. Since all investors hold the same portfolio The intercept point of CML and efficient frontier calls market or tangency portfolio. If investor is rational and risk-averse it will accept higher risk only when return increase proportionally. From this standpoint tangency portfolio is most efficient portfolio. If this article was helpful for you please thank our authors! $ DONATE ← Security Market Line, SML; Cost of Common Stock The point of tangency is the most efficient portfolio. Moving up the CML will increase the risk of the portfolio, and moving down will decrease the risk. Subsequently, the return expectation will also increase or decrease, respectively. All investors will choose the same market portfolio, given a specific mix of assets and the associated risk with them. You are free to use this image on your Teams. Q&A for work. Connect and share knowledge within a single location that is structured and easy to search. Learn more We can define all portfolios (and their constituent investments) with two parameters: expected return and standard deviation. Given those two parameters, you have a “frontier” of possible portfolios which gives you the highest return for the lowes... The intercept point of CML and efficient frontier would result in the most efficient portfolio called the tangency portfolio. As a generalization, buy assets if sharpe ratio is above CML and sell Tangency Portfolio The Tangency Portfolio is a portfolio that is on the efficient frontier with the highest return minus risk free rate over risk. In other words, it is the portfolio with the highest Sharpe ratio. Inputs. Expected Return of Riskless Asset - This can be determined from the U.S Treasury Bills or Bonds. The standard deviation of the Riskless asset is not required as this asset is

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