Learning Outcomes. After watching this video you will be able to determine how to optimally allocate your wealth across risky and risk-free assets. Distinguish between the investing decision and the financing decision. The optimal allocation between risky and risk-free assets. Once we identify the Mean Variance Efficient portfolio how do you decide what fraction of your wealth goes into the MVE portfolio? And what fraction into the risk-free asset? This is what we'll discuss this time. The optimal allocation between the MVE portfolio and risk-free asset depends on your coefficient of risk aversion. Earlier, we had solved for the optimal weight in a risky asset as w star equals expected return on the risky asset minus the risk free rate of return over A times sigma squared in the denominator. Here the MVE portfolio a risky asset. Remember that its expected return is 22.76% and its standard deviation is 9.16%. If we assume that the coefficient of risk aversion is 15 that is A equals 15 then the optimal weight in the MVE portfolio is 0.2276- 0.05 divided by 15 times 0.0916 squared. This works out to be 141.25%. If you have $100,000, then you should borrow $41,250 at the risk free rate of return and invest the total of $141,250 in the MVE portfolio. The $141,250 must be split between X, Y, and Z according to the proportions 0.2274, 1.7793, and a -1.0067, respectively. That is ,you should invest $32,120.25 in X. $251,326.125 in Y and short sell $142,196.375 of asset Z. All investors follow a two-step allocation process. One, identify the MVE portfolio which is the same for every investor. This is the investment decision. Two, decide on the split between the risk-free asset and the MVE portfolio. This depends on the investor's coefficient of risk aversion, and is the Financing decision. This is the separation property, because it consists of two independent tasks, namely the investing and financing decisions. Next time, we will start talking about asset pricing models that relate risk to return.