Which statement best describes the efficient frontier in portfolio theory?

Which statement best describes the efficient frontier in portfolio theory?

• A. The set of portfolios with minimum risk for any return
• B. The set of portfolios that offer the highest expected return for a given level of risk
• C. The set of all possible portfolios
• D. The single portfolio with maximum Sharpe ratio

Answer: (B)

The efficient frontier represents the best possible trade-off between risk and return in mean-variance optimization. For each level of risk (volatility), you can’t find a portfolio that offers a higher expected return without increasing risk; equivalently, for each target return, you can’t find a portfolio with lower risk. That description matches the idea of the frontier being the set of portfolios that offer the highest expected return for a given level of risk. In practice, risk is usually measured by standard deviation and returns by expected value; portfolios not on the frontier are suboptimal because they either earn less return for the same risk or involve more risk for the same return.

The efficient frontier represents the best possible trade-off between risk and return in mean-variance optimization. For each level of risk (volatility), you can’t find a portfolio that offers a higher expected return without increasing risk; equivalently, for each target return, you can’t find a portfolio with lower risk. That description matches the idea of the frontier being the set of portfolios that offer the highest expected return for a given level of risk. In practice, risk is usually measured by standard deviation and returns by expected value; portfolios not on the frontier are suboptimal because they either earn less return for the same risk or involve more risk for the same return.