Chapter 06 – Capital Allocation to Risky Assets
CHAPTER SIX
CAPITAL ALLOCATION TO RISKY ASSETS
CHAPTER OVERVIEW
This chapter describes the process of constructing of an investor portfolio. The two-step process
of constructing an investor portfolio involves selection of a portfolio of risky assets and deciding
LEARNING OBJECTIVES
After covering the chapter, the students should understand the concept of risk aversion and utility.
They should be able to apply the concept of risk aversion in measuring a utility function and
PRESENTATION OF MATERIAL
6.1 Risk and Risk Aversion
The concept of risk and return is developed by first distinguishing between speculation and
gambling. For speculation, one perceives a favorable risk-return trade-off. Table 6.1 presents an
6.2 Capital Allocation across Risky and Risk-Free Portfolios
The development of basic allocation between a risky asset and a risk-free asset begins by
Chapter 06 – Capital Allocation to Risky Assets
6-2
6.3 The Risk-Free Asset
6.4 Portfolios of One Risky Asset and A Risk-Free Asset
Section 6.4 develops the allocation of funds between risky and risk-free assets. When this
6.5 Risk Tolerance and Asset Allocation
With the development of two-asset allocation, the material in the chapter returns to incorporation
6.6 Passive Strategies: The Capital Market Line