The Modern Portfolio Theory (MPT) suggests that, without the ability to invest in a risk-free asset, a rational investor will select a portfolio (of only risky assets) on the efficient frontier (may or may not be the Market portfolio M) that best suits their investment needs. However, when the investor can invest in a risk-free asset, he/she can now select a portfolio that consists of the Market portfolio M (a specific portfolio that also lies on the efficient frontier) and the risk-free asset. If the investor is presented with both portfolios, explain which portfolio should this investor choose? Feel free to use graph to support you answer.

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When the investor can invest in a riskfree asset they have the opportunity to construct a portfolio that combines the riskfree asset with the market p... View the full answer