Answer: to the right of the market portfolio on the capital allocation line.

## Explanation In capital market theory, the Capital Allocation Line (CAL) represents all possible combinations of the risk-free asset and the market portfolio. The CAL is a straight line that connects the risk-free rate on the vertical axis to the market portfolio on the efficient frontier. ### Key Concepts: 1. **Capital Allocation Line (CAL)**: Shows risk-return trade-offs for portfolios combining the risk-free asset and the market portfolio. 2. **Market Portfolio (M)**: The point where the CAL is tangent to the efficient frontier. 3. **Investor Positions**: - **Lending Portfolio**: When an investor invests part of their wealth in the risk-free asset (lending at risk-free rate) and part in the market portfolio, they are positioned to the **left** of the market portfolio on the CAL. - **Borrowing Portfolio**: When an investor borrows at the risk-free rate to invest more than 100% of their wealth in the market portfolio, they are positioned to the **right** of the market portfolio on the CAL. ### Why Option B is Correct: - An investor who borrows at the risk-free rate is using leverage to invest more than their initial wealth in the market portfolio. - This creates a portfolio with higher expected return and higher risk than the market portfolio alone. - On the CAL, this position lies **to the right** of the market portfolio, as it represents a leveraged position. ### Why Other Options are Incorrect: - **Option A (above the CAL)**: Portfolios cannot exist above the CAL because the CAL represents the efficient frontier when combining the risk-free asset with the market portfolio. Any portfolio above would dominate the CAL, which violates the assumption of market efficiency. - **Option C (at the tangent point)**: This is the market portfolio itself, which represents an unleveraged investment in the market. The investor described in the question is borrowing, so they are not at the tangent point but beyond it. ### Mathematical Representation: The expected return of a portfolio combining the risk-free asset and the market portfolio is: $$E(R_p) = w_f R_f + w_m E(R_m)$$ where $w_f + w_m = 1$. For a borrowing investor: - $w_f < 0$ (borrowing at risk-free rate) - $w_m > 1$ (investing more than 100% in market portfolio) - This results in $E(R_p) > E(R_m)$ and $\sigma_p > \sigma_m$ Thus, the portfolio lies to the right of the market portfolio on the CAL.

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