Hi I am reading mod 53.2 and wondering whether or not my understanding of what happens to the points inside the efficient frontier is correct… A check would be of great help…
So do the points inside (below) the efficient frontier when constructing the CML become points ON the SML because CAPM assumes that all unsystematic risk inside the total risk have been removed through diversification? so then suddenly all the ‘inefficient’ securities become more ‘risk efficient?’ as Return/Risk increases due to subtraction of diversifiable risk in total risk?
As far as i remember -
In CML we assume that every investor will invest in the securities present on the efficient frontier (Which is Tobin’s Capital allocation line modified to Capital market line).
Now since every investor is buying the securities on the CML, securities below the CML starts losing demand and with that its price falls. With fall in price of the securities, its gets underpriced and the ROI shall increase. This continues over a period and over long term it enters the efficient frontier i.e CML.
Thanks Magician for taking out your time and correcting my mistake (Which on the first place I must apologize for… Sorry)
I also wanted to ask you if my understanding above is correct on securities below the efficient frontier.
Could you please confirm it? And also, would it be terrible if I ask you to share any other theory that you (obviously will be knowing) know on securities below the frontier?