Question

John Wilson is a portfolio manager at Austin & Associates. For all his clients, Wilson manages portfolios that lie on the Markowitz efficient frontier. Wilson asks Mary Regan, CFA, a managing director at Austin, to review the portfolios of two of his clients, the Eagle Manufacturing Company and the Rainbow Life Insurance Co. The expected returns of the two portfolios are substantially different. Regan determines that the Rainbow portfolio has a higher return and therefore concludes that the Rainbow portfolio must be superior to the Eagle portfolio. Do you agree or disagree with Regan's conclusion that the Rainbow portfolio is superior to the Eagle portfolio? Justify your response with reference to the capital market line.

Answer 1

Yes, I agree taht the conclusion provided by Regan is correct. We know that the market portfolio lies on the Capital Market Line. According to this, all the portfolios in CML are dominate and and we talk in terms of risk and return sense, the portfolios which lies on the Markowitz Efficient Frontier because the leverage is allowed, the CML creates a portfolio possibility lone which is above all the points of efficient frontier except for the market portfolio which is also called as Rainbow Portfolio.