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7. Optimal Portfolio

h. discuss the selection of an optimal portfolio, given an investor’s utility (or risk aversion) and the capital allocation line.

What is a risk-free rate of return (RFR)? A risk-free asset’s expected return is entirely certain.

What is a Capital Market Line (CML) and/or Capital Allocation Line (CAL)? The introduction of a risk-free asset changes the efficient frontier into a straight line. This straight efficient frontier line is called the Capital Market Line (CML) for all investors and the Capital Allocation Line (CAL) for one investor.

What is the separation theorem? Investors make different financing decisions based on their risk preferences. The separation of the investment decision from the financing decision is called the separation theorem.

What is an optimal portfolio? The optimal portfolio is the portfolio that gives the investor the greatest possible utility.