Quote:
Originally Posted by act_123
I"m still digesting.
p > sigma_d/sigma_e (invest all in debt)
Cov(d,e)/[sigma_d*sigma_e] > sigma_d/sigma_e
Cov(d,e) > sigma_d^2
If p = 1 then you would just invest entirely in debt in order to get the lowest variance.
Ahh I am still confused. I just don't understand why sigma_d/sigma_e is that threshhold.

Imo that threshold probably doesn't matter much for this exam but for a derivation, I think you can start with the fact Marcie outlined that the riskreturn curve develops a bend as correlation decreases.
That threshold would be hit for a correlation value in which the riskreturn curve gets a negative derivative. This is because diversification benefit creates a new min variance portfolio that's to the left of both debt and equity, so first the curve goes left (negative derivative) towards the new min variance portfolio then goes right (positive derivative) instead of the regular riskreturn curve that has a positive derivative and only 'goes right' so the minimum variance portfolio in this case is debt only.