Standard deviation of return

Figure 6.6 The minimum variance frontier.

3 189 189 f

Security 1 is always held long. Security 2 is held long if RF is less than and is held short for all values of Rf greater than Finally, security 3 is held long if Rp is greater than —4 and held short for values of RF below —4. The various values of Z as a function of Rp are shown in Figure 6.7.

The inclusion of almost all or all securities in the optimum portfolio makes intuitive sense. If a security's characteristics make it undesirable to hold, then the investor should issue it by selling it short. Thus, "good" securities are held and "bad" securities are issued to someone else. Of course, for someone else to be willing to take "bad" securities, there has to be a difference of opinion of what is good and bad.

appendix e

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