The market consists of two stocks. Stock F has an expected return of 9 percent and a standard deviation of 32 percent. Stock G has an expected return of 13 percent and a standard deviation of 50 percent. The correlation between the two stocks is -0.10. The efficient frontier is:
A) the line between Stock F and Stock G.
B) the line between the minimum variance portfolio and Stock F.
C) the line between the minimum variance portfolio and Stock G.
D) all to the right of Stock F on the risk/return graph.
E) all to the right of Stock G on the risk/return graph.

Question

Quizplus · Accepted Answer

The efficient frontier is the set of portfolios that offer the highest expected return for a given level of risk, or the lowest risk for a given level of return. In this case, the efficient frontier is the line between the minimum variance portfolio and Stock G. This is because Stock G has a higher expected return and a higher standard deviation than Stock F, but the negative correlation between the two stocks allows for diversification benefits when combined in a portfolio. Therefore, the most efficient portfolio will lie somewhere between the two stocks, closer to Stock G.

The Market Consists of Two Stocks