Which of the following factors reflect pure market risk for a given corporation? a. Optimal capital allocation to the risky asset, y:ġ. Sharpe ratio maximizing portfolio weights with two risky assets (D and E) and a risk-free asset: wD 5ģ E (rD ) 2 rf 4 sE2 2 3 E (rE ) 2 rf 4 sD sE rDEġ 3 E (rE ) 2 rf 4 sD2 2 3 E (rD) 2 rf 1 E (rE ) 2 rf 4 sDs E rDE Related Web sites for this chapter are available at KEY TERMS The expected rate of return on a portfolio: E(rp) 5 wDE(rD) 1 wEE(rE) The variance of the return on a portfolio: The Sharpe ratio of a portfolio: Sp 5 Nonsystematic risk diversifiable risk minimum-variance portfolio portfolio opportunity set Sharpe ratio optimal risky portfolio minimum-variance frontierĭiversification insurance principle market risk systematic risk nondiversifiable risk unique risk firm-specific risk

Risk pooling-the assumption of ever-more sources of risk-may increase rate of return predictability, but not the predictability of total dollar returns.Įfficient frontier of risky assets input list separation property risk pooling risk sharing Analogously, the key to the insurance industry is risk sharing-the spreading of risk across many investors, each of whom takes on only a small exposure to any given source of risk.

Increasing the investment horizon is analogous to investing in more assets.

Nor does investing over longer horizons reduce risk.

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