straight line efficient frontier

[FloWesh]

What exactly are the concepts behind constructing a straight line efficient frontier as required in Q6 of the Sept 2006 exam, and from which part of the current CT8 notes are we expected to decipher the solution from?
What about constructing a tangent to the efficient frontier as required in Qst 6 of the Sept 2007. Are these questions asking for similar things? I need some help with these, please

 

[Mike Lewry]

Chapter 4, Section 1.3 from p6 onwards deals with efficient frontiers and the question should be answerable based on a good understanding of this material. Chapter 6, Sections 1.3 to 1.5 are also relevant and worth a re-read.

Exam-style question 1 on p23 of Chapter 4 leads you on from the basics and asks similar things to Sept 2006 Q6, so you could try working through that.

Key concepts needed are:
1. If there's a risk-free asset (RFA), then the EF in E-sigma space will be a straight line
2. The gradient of a straight line in E-sigma space, going through the RFR and a portfolio p is [E(p)-r]/sigma(p)
3. The EF in this case goes through the risky portfolio that maximises the gradient in 2.

So in Sept 2006 Q6(ii), they're asking for the market portfolio, ie the risky portfolio that is on the overall EF.

For part (iii), we know 2 portfolios on the EF, ie the RFA and the market portfolio. So we can work out its equation and check that sigma=10% corresponds to E=7.69%

Yes, Sept 2007 Q6 is asking you to use a similar strategy. If you have the CT8 ASET, it's well worth studying that as we have 9 pages devoted to this question. If this is not an option, then you should be able to use the same key concepts above for part (iv)(a).