In: Finance
What does the efficient frontier represent?
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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