Assume all investors want to hold a portfolio that, for a given level of volatil

Question

Assume all investors want to hold a portfolio that, for a given level of volatility, has the maximum possible expected return. Explain why, when a risk-free asset exists, all investors will choose to hold the same portfolio of risky stocks. (Select the best choice below.) A. All investors will do the same thing-that is, they will minimize their volatilities-so they will all hold the same portfolio. B. All investors will do the same thing-that is, they will maximize their expected returns-so they will all hold the same portfolio. C. Investors who want to maximize their expected return for a given level of volatility will pick portfolios that maximize their Sharpe ratio. The set of portfolios that does this is a combination of a risk-free asset and a single portfolio of risky assets-the tangential portfolio. D. When a risk-free asset exists, it provides a safe investment opportunity. Given this safe investment opportunity, investors who maximize their expected returns for a given level of volatility will pick the same expected return and, hence, the same portfolio.

Explanation / Answer

Ans) Option c is correct . Investors who want to maximize their expected return for a given level of volatility will pick portfolios that maximize their sharpe ratio. the set of portfolios that does this is a combination of a risk-free asset and a single portfolio of risky assets - the tangential portfolio .

Explanation :- On a graph with standard deviation on the x-axis and expected return on y-axis draw the usual mean -variance efficient frontier of risky assets and add the line from the risk -free asset that is tangent to the mean -variance efficient frontier of risky assets .that line represents the mean variance efficient frontier of all assets . investors want to have as high a value on the y-axis aspossible as for a given x-axis value, so they want to be on the line .to be on the line, an investor holds a portfolio of the risk-free asset and the tangency portfolio.

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