“The tangency portfolio is the optimal risky portfolio because it has the highest possible expected reward-to-risk tradeoff.” Relative to what? Relative to other combinations of the risk free and a risky portfolio (ie other points along the capital allocation line)? Or relative to other risky portfolios (ie other points along the efficient frontier)? Is there somewhere with a fuller explanation of this whole concept than Schweser or CFA book? I find this one difficult to grasp.
This must be relative to the Markowitz efficient frontier. It cannot be relative to the Capital Allocation Line, because that depends upon the investor’s desired level of risk. If they are risk averse, they lend and move down the CAL with more Risk free rate in their portfolio. If they are riskheads and love it, they move up the CAL and leverage their portfolio by selling short the Risk free asset and piling more risky assets of the globally efficient portfolio into their own portfolio. The slope of the CAL is the Sharpe Ratio. Remember to multiply it by the investor’s desired standard deviation, and addback the Risk free rate. The CAL is the Capital Market Line (CML) morphed to take into account a particular investor’s desired level of risk. --------------------------------------------- The Security Market Line (SML) is different. It’s slope is CAPM. It measures systematic risk (Beta), whereas the CML and CAL measure total risk (both systematic and non-sys/firm-specific risk). It demonstrates the required return for an assets, and determines if that asset is over/under-priced.
cnd Wrote: ------------------------------------------------------- > “The tangency portfolio is the optimal risky > portfolio because it has the highest possible > expected reward-to-risk tradeoff.” > > Relative to what? Relative to other combinations > of the risk free and a risky portfolio (ie other > points along the capital allocation line)? Or > relative to other risky portfolios (ie other > points along the efficient frontier)? > > Is there somewhere with a fuller explanation of > this whole concept than Schweser or CFA book? I > find this one difficult to grasp. More to do with other risky assets portfolios where you either need to earn the same return or take the same risk.