Which of the following statements are (is) correct with respect to the Capital Allocation Line (CAL): O a. graphical depiction showing possible combinations of risk free and risky assets O b. assumes a linear / ship between risk and return O c. Slope = Sharpe Ratio O d. Helps investors determine an asset mix most suitable for them • e. All of the above
Question
Which of the following statements are (is) correct with respect to the Capital Allocation Line (CAL): O a. graphical depiction showing possible combinations of risk free and risky assets O b. assumes a linear / ship between risk and return O c. Slope = Sharpe Ratio O d. Helps investors determine an asset mix most suitable for them • e. All of the above
Solution
The correct answer is:
• e. All of the above
Here's why:
• a. The Capital Allocation Line (CAL) is indeed a graphical depiction showing possible combinations of risk-free and risky assets. It is used to illustrate the risk and return trade-off of different portfolios.
• b. The CAL does assume a linear relationship between risk and return. This is based on the assumption that higher risk should be compensated with higher expected returns.
• c. The slope of the CAL is equal to the Sharpe Ratio, which is a measure of risk-adjusted return. A steeper CAL (higher Sharpe Ratio) indicates a more efficient portfolio.
• d. The CAL helps investors determine an asset mix most suitable for them by showing the expected return for different levels of risk. Investors can use this to choose a portfolio that aligns with their risk tolerance and return objectives.
Therefore, all of the statements are correct with respect to the Capital Allocation Line (CAL).
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