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Answer: The risk-free asset exhibits no correlation with the other assets in the portfolio.
The inclusion of a risk-free asset in a portfolio of risky assets improves the risk-return trade-off because the risk-free asset has zero correlation with the risky assets. This zero correlation reduces the overall portfolio risk without affecting the expected return, leading to a more efficient portfolio. Option B is incorrect because the improvement in the risk-return trade-off arises from reduced risk, not lower returns. Option C is incorrect because the correlations among the risky assets remain unchanged; the benefit stems from the zero correlation between the risk-free asset and the risky assets.
Author: LeetQuiz Editorial Team
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The risk-return trade-off of a portfolio consisting solely of risky assets is most likely enhanced by the inclusion of a risk-free asset due to:
A
The risk-free asset exhibits no correlation with the other assets in the portfolio.
B
The lower return of the risk-free asset contributes to a diversification benefit.
C
The correlations between the risky assets diminish, thereby enhancing diversification.
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