question 5 from CFA text - introduction to portfolio management Markowitz Portfolio Theory is most accurately described as including an assumption that: A: risk is measured by range of expected returns B: investors have the ability to borrow or lend at the risk free rate of return C: investor utility curves demonstrate diminishing marginal utility of wealth D: investment decision making is based on both rational and irrational factors The answer is C, which i got right, but only by knowing it wasn’t the others. I don’t know why C is correct. How does the marginal utility of wealth come into play in the Markowitz portfolio theory?

good question, the efficient frontier is curved towards upper left, the investor utility curve is curved toward the lower right, the tagent point of the 2 curves are the profit maximizing point. If they don’t have a tangent point, use the cross point(s) instead.

The answer is B not C. Diminishing marginal utility of wealth was pretty played out by Markowitz’ time - certainly known to Bernoulli, Adam Smith, and others.

the correct answer, according to the book, is actually C. I thought it was B at first as well, however, that only applies to the CML and SML where the line is extended beyond the market portfolio. So, B is not the correct answer here b/c no such assumption is made for the markowitz portfolio theory. According to the text, Markowitz only got as far as the efficient frontier but didn’t make the next step to the market line.

Also, B should not say " investors have the ability to borrow or lend at the risk free rate of return ", but rather "investors have the ability to borrow *and* lend at the risk free rate of return "… yet I am surprised that C is the answer. "A " makes more sense as far as this theory is concerned.

DMF Wrote: ------------------------------------------------------- > the correct answer, according to the book, is > actually C. I thought it was B at first as well, > however, that only applies to the CML and SML > where the line is extended beyond the market > portfolio. So, B is not the correct answer here > b/c no such assumption is made for the markowitz > portfolio theory. According to the text, > Markowitz only got as far as the efficient > frontier but didn’t make the next step to the > market line. Actually, that’s true about Markowitz not making it to the CML.

Dreary Wrote: ------------------------------------------------------- > Also, B should not say " investors have the > ability to borrow or lend at the risk free rate of > return ", but rather "investors have the ability > to borrow *and* lend at the risk free rate of > return "… yet I am surprised that C is the > answer. "A " makes more sense as far as this > theory is concerned. A is incorrect because MPT doesn’t assume risk is represented by the “range” of expected returns but rather a probability distribution of expected returns.

Char-Lee, you mean by the standard deviation of expected returns?

zenji Wrote: ------------------------------------------------------- > Char-Lee, you mean by the standard deviation of > expected returns? correct, each investment alternative is represented by a probability distribution whereas the risk estimate of a portfolio is based on the variability of expected returns.

This question is a test to see if you know the laundry list of assumptions to the Markowitz portfolio theory. It is not a deep question but is a direct recall question. Simply flip to p. 229 to see that there are five asssumptions listed. The only one that is listed as an answer choice to the this quesiton is Choice “C”.

thanks cadlag

Is Markowitz’s portfolio theory in 2015 L3?

Answer B refers to the CAPM theory, not Markowitz. Even though both theories are strongly interlinked they are different theories/models. The CAPM theory was developed by Sharpe, Lintner and Mossin based on the assumptions of Markowitz.

Answer C is correct since the optimal portfolio in absence of a risk-free rate is the portfolio where an individual’s utility curve is tangent to the efficient frontier.

Regards,

Oscar