CFAI Text, Vol 3, P249~268 I am confused by the statements in the paragraph above the Example 10 : … On the other hand, as in Example 10, the highest-Sharpe Ratio efficient portfolio’s expected return may be BELOW the return objective. assuming that margin is not allowed, in such cases the highest-Sharpe Ratio efficient portfolio is not optimal for the investor. However, in Example 10, tthe highest-Sharpe Ratio efficient portfolio’s expected return (7.24%) is HIGHER the investor’s return objective (6.5%). Are above statements wrong ? Shall “a linear combination of 2 corner portfolios” be applied in case that the highest-Sharpe Ratio efficient portfolio’s expected return is HIGHER than the return objective ? Or shall CAL (Tangency Portfolio + Risk-Free Asset) be applied, since borrowing is not resticted in this example ? Other general questions : 1. In what scenarios CAL (Tangency Portfolio + Risk-Free Asset) shall be applied ? 2. In what scenarios “a linear combination of 2 corner portfolios” shall be applied ?
krnyc2008 Wrote: ------------------------------------------------------- > http://www.analystforum.com/phorums/read.php?13,1226913 I joined the discussions there, but my questions raised here were not answered there.
Bump! I’m going to see if i can summarize the process for selecting the optimal portfolio, given a level or required return. You’ve formulated CMEs and generated a batch of portfolios that maximize return for various levels of risk. You have a required rate of return. You want to maximize your return per risk taken: so, you want the portfolio with the highest Sharpe. If the portfolio with the highest Sharpe meets your return objective, you’re done. This is your tangency portf that meets your return objectives. Alas, that won’t happen on the exam, will it… If the tangency portfolio has a higher rate of return than required: you can proportionately decrease risk and return by allocating to the RFR, just enough to meet the required return. If the tangency portfolio has a lower return than required: 1) if you aren’t restricted from shorting, you can borrow at the rfr (weight rfr < 0) to achieve the required return using the portf w. the highest Sharpe 2) if you ARE restricted from shorting: you have to go to the portfolio with the highest Sharpe that does meet your required return. Here, you may be able to linearly combine adjacent corner portfolios (adjacent to your req’d return, that is). This linear combination will produce the highest possible Sharpe that meets your return requirements. I’m not exactly sure how RSF fits into this tho. What happens if the portfolio selected via the steps above doesn’t meet the IPS’s RSF?