Which of the following statements are true:

Which of the following statements are true:

I. All investors regardless of their expectations face the same efficient frontier which is always the market portfolio

II. Investors will have different efficient frontiers based upon their views of expected risks, returns and correlations

III. Investors risk appetite will determine their choice of the combination of risk-free and risky assets to hold

IV. If all investors have identical views on expected returns, standard deviation and correlations, they will hold risky assets in identical proportions
A . III and IV
B . II, III and IV
C . I and II
D . I, II, III and IV

View Answer

Answer: B

Explanation:

Investors have differing view of the market, which means differing view of expected returns, correlations and volatilities. Not only do they have differing views, these views change frequently as new information reveals itself. Accordingly, each investor has their own version of the efficient frontier. Once investors have determined their efficient frontiers, they will determine the extent of risk they wish to hold. If they had identical views, they would have held the same portfolio. But they do not, and if they did, there would be very little trading in the markets.

All the above statements are true except statement I which is false due to differing investor expectations.

(Re statement IV: If investors have different risk appetites, their portfolio will vary in the split between the risky and the riskfree assets. But inside the ‘risky’ assets bundle the proportion of the assets will be identical. Ie, they would express their varying risk appetites by varying how much of the risky bundle and the riskfree asset they hold, but inside the risky bundle the proportion of the different risky assets will be the same.)