Efficient Frontier Analysis

1059 WordsNov 16, 20105 Pages
The definition of the efficient frontier says that “the efficient frontier represents the set of portfolios that has the maximum rate of return for every given level of risk, or the minimum risk for every level of return.” I plotted standard deviation on x axes and Returns on y axes to interpret efficient frontier. Exhibits also include these and the graphs you asked for as graph2: In our study, we concentrated on the optimal portfolios, the one which has the lowest volatility or risk, for given level of return. The area below the frontier shows the achievable risk-return combinations, there will be at least one portfolio constructible that has the risk and return corresponding to that point. No portfolio on the efficient frontier can…show more content…
As seen in table below. STD EX® NAME EX®)/STD 4.560897 -0.07629 WMT -0.01673 6.62584 0.4643 HD 0.070074 4.832779 0.618 C 0.127877 4.519264 0.705732 HSY 0.156161 7.630042 0.805847 MRK 0.105615 5.243063 0.836464 IBM 0.159537 2.851834 0.867592 EQUAL 0.304222 10.58777 2.719098 BBY 0.256815 As seen in exhibit 11 if we add MCD to our portfolio and solve for without short selling we can see that the efficient frontier moved to the left. In other words it improved. This is due to diversification. By the same intuition, as seen in exhibit 12, if we add LMT to our portfolio efficient frontier improved even further. To see the difference, we can check exhibit 12.The reason that adding LMT improved efficient frontier even further is because of the fact that while MCD has positive correlation as seen in the correlation matrix ,in exhibit 1 whereas LMT is negatively correlated leading to more reduction in the risk of the portfolio due to diversification. Due to the point where the curves intersect (the point when expected return is between 1.5 and 1.75) the portfolios including LMT are more efficient until expected return is 1.75 whereas after the point the portfolios with MCD become more efficient if expected return is equal to higher than 1.75.This may be due to the marginal diminishing returns that reverse the marginal utility the portfolio gains by increasing expected return. Up to that point if we divide the expected
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