Question

Mutual fund separation method determines weights of risky securities by maximizing the

Select one:

a. portfolio beta.

b. investor's utility.

c. slope of Capital Allocation Line.

d. portfolio return.

Answer 1

Mutual fund separation theorem follows the tenet of the Modern portfolio theory and therefore depends on Mean-Variance optimization which suggests that we maximize Expected return to risk ratio. Slope of CAL is also this ratio therefore MF separation theorem looks to maximize the slop of CAL. So the correct option is C. The allocation of funds among different assets is done by calculating the ratio for each asset and then the combination which maximizes the ratio is selected therefore this is how the weights are determined.

Portfolio beta implies the portfolio's systematic risk and as higher risk is not recommended, it is not the criteria to be maximized. So option a is incorrect.

Investors utility and Portfolio return in isolation do not include the risk factor so even options b and d are incorrect.