Portfolio Theory This question is designed to test your understanding of the mean standard deviation diagram.

(a) Draw a mean-standard deviation diagram to illustrate combinations of a risky asset and the risk-free asset.

(b) Extend this concept to a diagram of the risk-free asset and all possible risky portfolios.

(c) Why does one line, the capital market line, dominate all other possible portfolio combinations?

(d) Label the capital market line and that optimal portfolio.

(e) What condition must hold at the optimal portfolio?