This module is part of the 2027 curriculum. You are following the 2026 curriculum, where it is not taught in this form. Switch if you are sitting the exam under the 2027 curriculum.
Lesson 11 of 13 · 14 min
Optimal risky portfolio and the optimal investor portfolio
Adding a risk-free asset turns portfolio choice into two steps: everyone picks the same optimal risky portfolio, then each investor chooses how much to lend or borrow.
In short
- Combining the risk-free asset with any efficient portfolio gives a CAL; the best one is the steepest, tangent to the efficient frontier.
- The tangency portfolio is the optimal risky portfolio; its CAL dominates every other CAL and the efficient frontier (except at the tangency point).
- Two-fund separation: all investors hold the risk-free asset and the same optimal risky portfolio.
- Step 1, the investment decision, ignores preferences; step 2, the financing decision, uses each investor's indifference curves.
- Highly risk-averse investors sit near (lending); less risk-averse investors sit at or beyond the optimal risky portfolio (borrowing).
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