Question
Why will rational risk-averse investors only choose portfolios on the efficient frontier?
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Answer
Portfolios below it are dominated by higher-return portfolios at the same risk.
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Question
Why does a risk-averse investor require a higher expected return to hold a riskier asset?
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Answer
Additional risk creates disutility, so compensation is required.
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Question
Why is correlation often more useful than covariance for judging diversification potential?
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Answer
It standardizes co-movement on a bounded scale from −1 to +1.
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Question
Why can diversification improve the risk-return tradeoff without reducing expected return?
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Answer
It lowers risk for a given expected return when correlations are below +1.
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