Draw graphs that represent each of the following situations: Investors face an e

Question

Draw graphs that represent each of the following situations:

Investors face an efficient frontier of risky assets. There is no borrowing or lending allowed at a risk-free rate. Using indifference curves, show an example of the optimal portfolio choice for Investor A, who has a strong aversion to risk, and one for Investor B, who is much less risk-averse. Label points A and B clearly.

Investors face an efficient frontier of risky assets. Borrowing and lending at a risk- free rate are allowed. Using indifference curves, show an example of Investor C, who chooses to put 100% of his investment in the optimal risky portfolio. Show an example of Investor D, who chooses to put 75% of her investment in the optimal risky portfolio. Label points C and D clearly.

Investors face an efficient frontier of risky assets. Lending at a risk-free rate is allowed, and investors can borrow at a slightly higher rate. Using an indifference curve, show an example of Investor E, who chooses to borrow. Label this point E. On the same graph show where the investor's indifference curve would be if she could borrow at the lending rate. Label this point F.

Explanation / Answer

Answer: The graph of investors A and B should resemble Figure 8-15 on page 237. The graph of investors C and D should look like Figure 8-8 on page 222, with C lying to the left of P and point D to the right of P. The graph with points E and F is similar to Figure 8-16 on page 237.

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