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

Two investors face the same capital allocation line formed from the risk-free asset and the optimal risky portfolio. Investor 1 is more risk averse than Investor 2. Which statement best describes their optimal complete portfolios?

Both investors hold the same optimal risky portfolio, and the more risk-averse Investor 1 simply allocates a smaller weight to it and more to the risk-free asset. Risk tolerance determines the position along the CAL, not the composition of the risky portfolio.

  1. ABoth hold the same mix of risky assets but Investor 1 allocates a smaller weight to the optimal risky portfolioCorrect
  2. BInvestor 1 holds a different optimal risky portfolio from Investor 2 with lower expected return
  3. CInvestor 1 holds the same weight in the risky portfolio as Investor 2 but selects different risky assets

Explanation

With a single risk-free rate and common expectations, all investors hold the same optimal risky portfolio (the separation of choice of risky portfolio from risk attitude). Risk aversion only determines how much is placed in it versus the risk-free asset, so the more risk-averse investor holds a smaller weight.

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