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.
frontcon has been removed. Use
portopt has been partially
removed and will no longer accept
portopt will only solve the portfolio
problem for long-only fully invested portfolios. Use