SIE practice questionhardRisk — Modern Portfolio Theory
According to Modern Portfolio Theory, the 'efficient frontier' represents:
- AThe set of portfolios offering the highest expected return for each level of risk (or the lowest risk for each level of return)✓ Correct answer
- BThe minimum investment needed to achieve diversification
- CThe maximum amount of risk an investor should take
- DA line showing all portfolios with equal risk
Explanation
Why A — The set of portfolios offering the highest expected return for each level of risk (or the lowest risk for each level of return)
The efficient frontier is a key concept from Modern Portfolio Theory (MPT) developed by Harry Markowitz. It represents the set of optimal portfolios that offer the maximum expected return for a given level of risk, or equivalently, the minimum risk for a given expected return. Portfolios below the efficient frontier are sub-optimal (better risk/return combinations exist). MPT demonstrates that proper diversification can improve a portfolio's risk-adjusted returns.
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