Efficient Frontier and Portfolio Selection

Efficient Frontier and Portfolio Selection

The portfolio is selected by the introduction of a borrowing and lending line making the efficient frontier a straight line. Illustration 7 shows a risk-free security of 6% with a standard deviation of 6.90. The graph represents a portfolio return and risk and the best portfolio is the corner portfolio of 9 . The corner which is beyond 9 and to its left, i.e. from 10 to 17 can be introduced to a greater efficiency and made efficient by selecting 9 with an addition of the fact of leading. The choice of portfolio which are on the right side of 9 i.e.from 1 to 8 are seen to show borrowing and are in some way dominated by 9 . 9 is the stage in which the maximum benefit can be derived after using the formula

(Rp   Rt /bp).

risk. In the selection of a portfolio, both negative and positive betas should be considered. While assessing a portfolio on beta, the negative beta should be preferred to positive beta. The presence of negative beta in a portfolio if efficient. Also, there is reduced or eliminated amount of risk when the negative betas are present.

Although betas help in selecting stock, care should be taken to select the  stock with the beta approach because selection of portfolio with beta is followed only when the following assumptions are considered:

(a)  The market movement in positives and negatives directions haves to be carefully analyzed

and

(b) The past historical considerations of beta must be analyzed for future

prediction of beta.

(a)the sensitivity of the security to inflation;

(b) economics events as Market Index causes systematic change and

(c) Risk and return with portfolio.

The fundamental factors are the following:

(a)the earning of a firm;

(b) the movements of the market;

(c) continuous valuation of stock;

(d) survey of stock, whether it represents large or small firms, old and established and new firms;

(e) growth of firms historically and

(f) The capital structure of the firm.