Question

The optimal risky portfolio can be identified by finding _____________.

I. the minimum variance point on the efficient frontier
II. the maximum return point on the efficient frontier the minimum variance point on the efficient frontier
III. the tangency point of the capital market line and the efficient frontier
IV. the line with the steepest slope that connects the risk free rate to the efficient frontier

Answer 1

The optimal risky portfolio can be identified by finding the tangency point of the capital market line and the efficient frontier

Step-by-step explanation:

Given the best risky portfolio and risk-free assets, we can construct the capital allocation line, which basically gives us the risk and return trade-offs that we can attain.

The slope of this capital allocation line gives us the excess reward per unit of risk provided by the risky portfolio. We obtain the solution to this problem by maximizing utility subject to the risk and return combinations that we can achieve, which essentially boil down to finding the tangency point, the highest indifference curve, and the capital allocation line.