Q: Compare your optimal risky portfolio characteristics to those of the two individual stocks used in the portfolio. What do you find?
or
Q: Compare your optimal risky portfolio characteristics to those of the two individual stocks used in the portfolio. What do you discover?
- The optimal risky portfolio displays the same Sharpe Ratio as at least one of the two stocks used in the portfolio.
- The optimal risky portfolio displays a lower Sharpe Ratio than either of the two stocks used in the portfolio.
- The optimal risky portfolio displays a higher Sharpe Ratio than either of the two stocks used in the portfolio.
Explanation: When constructing an optimal risky portfolio, the goal is to maximize the Sharpe Ratio by finding the best combination of assets to optimize the risk-return trade-off. This portfolio generally displays a higher Sharpe Ratio than either of the two individual stocks used in its construction. This result arises because diversification reduces the portfolio’s total risk without proportionally reducing the expected return, thereby improving the risk-adjusted return.
