The Capital Allocation Line provided by a risk-free security and N risky securities is
A) the line that connects the risk-free rate and the global minimum-variance portfolio of the risky securities.
B) the line that connects the risk-free rate and the portfolio of the risky securities that has the highest expected return on the efficient frontier.
C) the line tangent to the efficient frontier of risky securities drawn from the risk-free rate.
D) the horizontal line drawn from the risk-free rate.
E) none of these.

Question

Quizplus · Accepted Answer

The Capital Allocation Line (CAL) is the line that connects the risk-free rate to a portfolio of risky securities. The portfolio of risky securities is constructed by combining different weights of N risky securities in such a manner that the portfolio lies on the efficient frontier. The line that results from connecting the risk-free rate to this portfolio is known as the CAL. The CAL is tangent to the efficient frontier at the point where the portfolio of risky securities that forms a part of the CAL meets the efficient frontier. This point is known as the market portfolio. Thus, option C is the correct answer. Option A is incorrect because it connects the global minimum-variance portfolio of risky securities to the risk-free rate, not the CAL. Option B is incorrect because the portfolio with the highest expected return on the efficient frontier is not always the same as the market portfolio. Option D is incorrect because it involves drawing a horizontal line from the risk-free rate, which does not account for the risk associated with the portfolio of risky securities. Option E is incorrect because option C is the correct answer.

The Capital Allocation Line Provided by a Risk-Free Security and N