Analyzing Portfolios

Portfolio managers concentrate their efforts on achieving the best possible trade-off between risk and return. For portfolios constructed from a fixed set of assets, the risk/return profile varies with the portfolio composition. Portfolios that maximize the return, given the risk, or, conversely, minimize the risk for the given return, are called optimal. Optimal portfolios define a line in the risk/return plane called the efficient frontier.

A portfolio may also have to meet additional requirements to be considered. Different investors have different levels of risk tolerance. Selecting the adequate portfolio for a particular investor is a difficult process. The portfolio manager can hedge the risk related to a particular portfolio along the efficient frontier with partial investment in risk-free assets. The definition of the capital allocation line, and finding where the final portfolio falls on this line, if at all, is a function of:

  • The risk/return profile of each asset

  • The risk-free rate

  • The borrowing rate

  • The degree of risk aversion characterizing an investor

Financial Toolbox™ software includes a set of portfolio optimization functions designed to find the portfolio that best meets investor requirements.

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