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Question - Describe how adding a risk-free security to modern portfolio theory allows investors to do better than the efficient frontier. Explain how might the magnitude of the market risk premium impact people's desire to buy stocks?

Answer - Finance - The investors can hold the best portfolios with the risky assets would be the efficient portfolios over the efficient frontier. At the risk-free rate, if the investors can lend and borrow then they would perform in an appropriate manner. The investors for improving their performance within the efficient frontier should allocate their portfolios to the market portfolio and risk-free rate. The investors by creating a balance between the two would be able to determine the portfolio (Mangram, 2013). The portfolio would consist of the same risk level which is associated with an efficient portfolio but it would consist of higher expected return. Different investors face different risk aversion within the market. Investors who have low-risk aversion level would like to purchase stocks consisting of higher risk. On the other hand, the investors who have a high-risk aversion level would like to purchase stocks consisting of lower risk. Thus, it can be said that the magnitude of the risk premium imposes a significant impact on the investors while purchasing the stocks. Therefore, it is being found that investors should understand the situation and create a balance before purchasing stocks.

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