Define the efficient frontier.

• A. The set of optimal portfolios offering the highest expected return for a given level of risk (or lowest risk for a given return)
• B. The line of portfolios with the lowest possible return
• C. The set of portfolios with identical risk
• D. The region with the highest volatility

Answer: (A)

The efficient frontier is the best trade-off between risk and return when choosing portfolios. In mean-variance terms, it’s the boundary of all feasible portfolios: for any given level of risk, it lists the highest possible expected return, and for any given level of return, the lowest possible risk. Each point on this frontier is a Pareto-optimal choice, meaning you can’t improve return without raising risk or reduce risk without lowering return. Diversification and how asset returns move together shape this curve, with the frontier rising as you balance greater return against more risk. So the statement describing the frontier as the set of optimal portfolios offering the highest expected return for a given level of risk (or the lowest risk for a given return) is the correct one. Portfolios below the frontier are suboptimal because you can either increase return without adding risk or reduce risk without sacrificing return.