Question 1The probability distribution assumption about returns on risky assets is that returns are stochastic and normally distributed around the average return. This hypothesis allows statistical analysis and modeling of returns. Model assumptions are listed below. i) No transaction costs for buying or selling an asset. Since transaction costs normally represent a minimum percentage of the investment, they become of minor importance to investors and reduce the complexity of the capital asset pricing model (CAPM).ii) Assets are divisible at infinity. An investor can take any position in an investment, whether it is a managed fund or Australian shares. For example, buying one dollar worth of BHP Billiton shares. iii) Absence of personal income tax. iv) Regardless of the size of an investment, an individual cannot influence the stock price himself. Similar to “perfect competition” are the assumptions on which investors broadly determine prices. v) Investors are expected to make financial decisions based solely on the expected return and variance of returns in their desired portfolio. vi) Unlimited short selling is legal. This involves selling a security that you do not own, in the hope of buying it back. Therefore, an investor may want to short $50,000 worth of BHP stock. vii) Unlimited borrowing and lending at the risk-free rate. viii) Homogeneity of expectations. Thus, investors are concerned with the mean and variance of returns and all investors have identical expectations regarding these data in the portfolio decision. ix) All assets are tradable and therefore can be sold and bought in some form of market. Some assumptions will be valid. for the CAPM, whether it is a simple or two-factor general equilibrium mode...... middle of paper ......t managers must be able to identify the limits and the risks associated with the MVO to ensure that the estimation error is minimized and to take into account the total cost of the portfolio.References1) Fama, EF; French, KR (2004) The financial asset pricing model: theory and evidence. Journal of Economic Perspectives: Volume 18.3 pp 25-46.2) EJ Elton, MJ Gruber, SJ Brown and WN Goetzmann, Modern Portfolio Theory and Investment Analysis, J. Wiley & Sons (8th edition) 2009.3) Lummer, SL, Reipe, MW & Siegel, LB, 1994. Taming Your Optimizer A Guide Through the Pitfalls of Mean-Variance Optimization. In: J. Lederman and RA Klein, eds. Global asset allocation: portfolio management optimization techniques. sl: John Wiley & Sons.4) Rajkumar, S. and Dorfman, M. 2011. Governance and investment of public pension assets. Washington, DC: World Bank.