Which of the following best describes the efficient frontier?

Which of the following best describes the efficient frontier?
A . The efficient frontier identifies portfolios with the lowest return per unit of volatility
B . The efficient frontier identifies portfolios with the highest return per unit of volatility
C . The efficient frontier identifies the market portfolio
D . The efficient frontier identifies portfolios with the highest volatility for a given level of return

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Answer: B

Explanation:

The efficient frontier is plotted on a graph with portfolio return (mean) as the y-axis and portfolio volatility, or standard deviation, on the x-axis. For a given level of volatility, it identifies the portfolio with the maximum return. Therefore Choice ‘b’ is the correct answer. If a reading is taken from the y-axis (ie returns) by dropping a perpendicular line on to the efficient frontier, we can get the minimum risk portfolio for the given level of returns. So the efficient frontier can be used to identify either the highest return per unit of volatility, or the lowest volatility given a desired level of returns. The efficient frontier does not describe the market portfolio, though the market portfolio may be one of the many points on the efficient frontier. Thus the other choices are incorrect.