Risk Free Borrowing and Lending
RISK-FREE BORROWING AND LENDING: Assume that the efficient frontier, as shown by the arc AB in Figure 9-1, has been derived by an investor. The arc AB delineates the efficient set of portfolios of risky assets as explained in (For simplicity, assume these are portfolios of common stocks.) We now introduce a risk-free asset with return RF and σ = 0 . As shown in Figure 9-1, the return on the risk-free asset (RF) will plot on the vertical axis because the risk is zero. Investors can combine this riskless asset with the efficient set of portfolios on the efficient frontier. By drawing a line between RF and various risky portfolios on the efficient frontier, we can examine combinations of risk-return possibilities that did not exist previously. Lending Possibilities: In Figure 9-1 a new line could be drawn between RF and the Markowitz efficient frontier above point X, for example, connecting RF to point V. Each successively higher line will dominate the preceding set of po...