How is the reduction- and elimination of portfolio risk achieved? Should priority be given to a zero- risk portfolio or maximizing return at an acceptable level of risk? Explain briefly. Please read your coursebook and notes carefully, write down your own ideas, and make sure your discussion does not exceed half a page.

Generally, the principle of risk-return trade-off operates. This means that as the risk on any portfolio increases, the risk associated with that portfolio also increases. This risk can be reduced by including multiple securities in the portfolio that are not perfectly correlated or preferably negatively correlated. And this process is called diversification which helps in reducing the overall portfolio risk.

If one chooses a zero risk porfolio, it will generate the risk-free rate of return on the portfolio. However, one can maximize return by investing on the efficient portfolio at an acceptable level of risk. The priority must be given to the second option. The efficient frontier gives us the maximum return at a given level of risk that could be much higher than the risk free rate of return. Hence, the return-to-reward ratio is much higher for the second alternative and hence, it must be preferred.

Also, how much risk an investor wants to take is completely upto his discretion. If he is highly risk averse, most appropriate for him to go for the minimum variance portfolio. If he is neutral to rsk, then he must invest in optimal risky portfolio. Because there is no point in creating a portfolio, if one wants to take no risk. In such case, he can simply put all his money in the government securities such as Bonds and T-Bills that would generate the risk free return.