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CFA Level I · CFA Level I Exam · Portfolio Risk and Return: Part II

An investor draws the efficient frontier for risky assets and then combines the risk-free asset with the risky portfolio at the tangency point. The optimal risky portfolio for the investor is most likely the portfolio that:

The optimal risky portfolio is the tangency portfolio that maximizes the Sharpe ratio. When a risk-free asset is available, every investor holds this same risky portfolio and adjusts risk only by changing the mix of risk-free asset and risky portfolio, so risk aversion does not change it.

  1. Ahas the lowest standard deviation on the efficient frontier
  2. Bmaximizes the Sharpe ratio, regardless of the investor's risk aversionCorrect
  3. Cmatches the investor's risk tolerance by lying where an indifference curve touches the frontier

Explanation

With a risk-free asset, the capital allocation line tangent to the frontier gives the highest Sharpe ratio. All investors hold that same risky portfolio and vary only the weight in the risk-free asset. The global minimum-variance portfolio and the indifference-curve tangency describe the no-risk-free-asset case.

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