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CFA Level I · CFA Level I Exam · The Return and Risk of a Financial Portfolio

Investors with different degrees of risk aversion face the same risk-free rate and the same set of risky assets. Under the standard mean–variance framework with a risk-free asset, the optimal risky portfolio for these investors is most likely:

The optimal risky portfolio is the same for all investors: the tangency portfolio with the highest Sharpe ratio. Risk aversion affects only the mix between that portfolio and the risk-free asset. This is the separation of the investment decision from the financing decision.

  1. Athe same for all, with differences in risk aversion reflected in the weight placed in the risk-free assetCorrect
  2. Blower in risk for more risk-averse investors, who choose a different tangency portfolio
  3. Cdetermined by each investor's indifference curve, so it differs across investors

Explanation

The optimal risky portfolio is the tangency portfolio, which has the highest Sharpe ratio and depends only on asset inputs and the risk-free rate. Investor risk aversion then determines how much is allocated to it versus the risk-free asset, which is the separation theorem. The other options wrongly make the risky portfolio depend on preferences.

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