6.Choose the statement which is most correct about portfolio allocation theory:

Question

6.Choose the statement which is most correct about portfolio allocation theory: a. Investment in only a risk free asset is not an efficient portfolio, i.e., a portfolio invested in only the risk-free asset does not fall on the “best, feasible, capital allocation line.” b. If the market is efficient, superior asset selection skills yield preferable results to asset allocation and efficient diversification techniques. c. in creating a portfolio, the optimal combination of risky assets is independent of investor preferences; though investor risk preferences may determine how much of the total protfolio is invested in the risk-free asset versus the optimal portfolio d. an investor willing to accept more risk for higher return would increase her proportionate investment inthe higher risk/higher return asset, since that is less risky than leveraging the portfolio e. the "best" portfolio combination of risky assets is the one with the lowest standard deviation

Explanation / Answer

The risk free asset lies on the capital allocation line of the efficient portfolios thus  risk free asset is an efficient portfolio therefore a. Investment in only a risk free asset is not an efficient portfolio, is incorrect.

"best" portfolio combination of risky assets is the one with the highest Sharpe ratio(return to risk slope) therefore e. the "best" portfolio combination of risky assets is the one with the lowest standard deviation is incorrect.

Investor can also increase risk for return through leveraging thus d is also not 100% correct.

b seems inappropriate.

c. in creating a portfolio, the optimal combination of risky assets is independent of investor preferences; though investor risk preferences may determine how much of the total portfolio is invested in the risk-free asset versus the optimal portfolio is the most correct about portfolio allocation theory. The optimal risky portfolio is determined with the sole intention of maximizing the Sharpe ratio without consideration to investor preferences the investor preferences however determines what proportion of investment he wants in the risk-free asset versus the optimal portfolio.

Thus choose c.

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