When borrowing and lending at a risk-free rate are allowed, which capital allocation line (CAL) should the investor choose to combine with the efficient frontier?I) The one with the highest reward-to-variability ratio.II) The one that will maximize his utility.III) The one with the steepest slope.IV) The one with the lowest slope.
A) I and III
B) I and IV
C) II and IV
D) I only
E) I, II, and III

Question

Quizplus · Accepted Answer

The correct choices are I, II, and III. The CAL with the highest reward-to-variability ratio (I) is equivalent to the one with the steepest slope (III), as both indicate the highest return per unit of risk, which is desirable for investors. Additionally, investors should choose the CAL that maximizes their utility (II), as this aligns with their risk tolerance and investment goals. The one with the lowest slope (IV) would not be preferred because it offers lower returns for a given level of risk.

When Borrowing and Lending at a Risk-Free Rate Are Allowed