1.a.2. CML & SML？

[ckyeh]

Dear David:

On the spreadsheet 1.a.2. CML & SML,
you let the percent of portfolio A and B be 56.4% and 43.6%.
I just wonder why you randomly chose the number "56.4%" and "43.6%".
I mean, why don't you chose a number easily to understand?
For example, 20% and 80%.

Is it because you chose 56.4% and 43.6% for some reason?
Thanks for your help!

CKyeh

 

[David Harper CFA FRM]

Hi Ckyeh,

If you look at columns K-N on the right side, you will see the reason. I could have simply given input assumptions for the Market Portfolio; instead, I here assume (with ridiculous simplicity), that the entire market consists of only the two assets (A) and (B), just like the two-asset portfolio. (It's silly b/c an important theoretical assumption of CML under MPT is that the market includes everything risky that is investable).

The reason I did that is to illustrate that the Market Portfolio (M) maximizes the Sharpe ratio (which is also the slope of the CML!). So, 20/80%, you can see, is a Sharpe of only 0.42 rather than the optimal 0.46
(this thread gives a little more insight, based on changing the Rf rate, where you can see that my simple model requires running solver to find the new optimal mix if you change the Rf rate: http://forum.bionicturtle.com/viewreply/5603/)

Hope that helps, thanks, David