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In: Finance

What does the efficient frontier represent?

What does the efficient frontier represent?

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Expert Solution

Most investment choices involve the choices between risk and reward.
The efficient frontier is a modern portfolio theory tool that shows the investors the best possible return they can expect from their portfolio given the volatility of the returns they can expect.
The chart given in the image depicts the concept. The X- axis depicts the expected rate of return, the horizontal axis signifies the investor's risk tolerance.







The Frontier is the yield curve that represents the yield of portfolios given the level of risks.
The following points are very important :-

1.) Any portfolio above this curve is impossible.
2.) Optimal portfolios should lie on this curve.
3.) Any portfolios that lie below the curve represent a less than optimal mix of investments because for the same risk the investor can earn a greater return.




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