CFA Level I · CFA Level I Exam · Portfolio Risk and Return: Part I
An investor combines a risk-free asset with a single risky portfolio. The expected return of the combined portfolio, when plotted against its standard deviation, most likely lies on:
The combinations lie on a straight line called the capital allocation line. The risk-free asset has zero standard deviation and zero correlation with the risky portfolio, so both portfolio return and risk are linear in the weight placed in the risky portfolio.
- Aa straight line called the capital allocation lineCorrect
- Ba curve that is concave to the origin, called the efficient frontier
- Ca curve that is convex to the origin, called the minimum-variance frontier
Explanation
Because the risk-free asset has zero variance and zero correlation with the risky portfolio, the combined standard deviation equals the risky weight times the risky portfolio's standard deviation. Expected return is also linear in that weight, so the combinations plot as a straight line, the capital allocation line. The other options describe frontiers of multiple risky assets.
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