RMontgomery

got it thanks. rfr doesnt move once you invest in it, so its correlation with anything else is zero sicne it does not ever change. just came across another relatively simply PM question...can you help me to reason out why B is incorrect here?



Portfolio Management Associates (PMA) provides asset allocation advice for pensions. PMA recommends that all their pension clients select an appropriate weighting of the risk-free asset and the market portfolio. PMA should explain to its clients that the market portfolio is selected because the market portfolio:

A) maximizes the Sharpe ratio.

B) maximizes return and minimizes risk.

C) maximizes return.


Your answer: B was incorrect. The correct answer was A) maximizes the Sharpe ratio.

The risk and return coordinate for the market portfolio is the tangency point for the capital market line (CML). The CML has the steepest slope of any possible portfolio combination. The slope of the CML is the Sharpe ratio. Therefore, the Sharpe ratio is highest for the market portfolio.