What is the efficient frontier according to Modern Portfolio Theory?

What is the efficient frontier according to Modern Portfolio Theory?

• A. A graphical representation of all possible investments
• B. A graph of optimal portfolios
• C. A model for predicting stock prices
• D. None of the above

Answer: (B)

The efficient frontier, according to Modern Portfolio Theory (MPT), is fundamentally a graph that represents a set of optimal portfolios that provide the highest expected return for a given level of risk. These portfolios are constructed in a way that minimizes the risk for a target level of expected return, or maximizes returns for a given level of risk, effectively making them the most efficient combinations of risk and return. In the context of MPT, the efficient frontier is shaped like a curve in a risk-return graph, where the horizontal axis represents the risk (usually measured by standard deviation) and the vertical axis represents expected returns. Portfolios that lie on the efficient frontier are considered efficient because they cannot be improved upon without increasing the risk; that is, no other portfolio offers a higher return for the same level of risk or a lower risk for the same level of return. The other answer choices do not accurately capture the essence of the efficient frontier. While choice A implies a broader representation of all investments which is not specific to efficiency in terms of risk and return, and choice C mischaracterizes the purpose of the efficient frontier, focusing incorrectly on predictive models rather than optimal investment combinations. Therefore, the correct perspective is that the efficient frontier graphically illustrates portfolios that are deemed

The efficient frontier, according to Modern Portfolio Theory (MPT), is fundamentally a graph that represents a set of optimal portfolios that provide the highest expected return for a given level of risk. These portfolios are constructed in a way that minimizes the risk for a target level of expected return, or maximizes returns for a given level of risk, effectively making them the most efficient combinations of risk and return.

In the context of MPT, the efficient frontier is shaped like a curve in a risk-return graph, where the horizontal axis represents the risk (usually measured by standard deviation) and the vertical axis represents expected returns. Portfolios that lie on the efficient frontier are considered efficient because they cannot be improved upon without increasing the risk; that is, no other portfolio offers a higher return for the same level of risk or a lower risk for the same level of return.

The other answer choices do not accurately capture the essence of the efficient frontier. While choice A implies a broader representation of all investments which is not specific to efficiency in terms of risk and return, and choice C mischaracterizes the purpose of the efficient frontier, focusing incorrectly on predictive models rather than optimal investment combinations. Therefore, the correct perspective is that the efficient frontier graphically illustrates portfolios that are deemed