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 tradeoff when combining risk-free asset with risky portfolio
2. Market Portfolio: The tangency point where CAL touches the Markowitz efficient frontier
3. Investor positions on CAL:
   • Left of market portfolio: Lending at risk-free rate (investing in risk-free asset)
   • At market portfolio: 100% invested in market portfolio
   • Right of market portfolio: Borrowing at risk-free rate to invest more than 100% in market portfolio

Why option B is correct:

• When an investor borrows at the risk-free rate to invest more than 100% in the market portfolio, they are taking a leveraged position
• This leveraged position lies to the right of the market portfolio on the CAL
• The investor is essentially moving along the CAL beyond the market portfolio point

Why other options are incorrect:

• Option A: Portfolios cannot be above the CAL because the CAL represents the optimal risk-return tradeoff
• Option C: This describes the market portfolio itself (tangency point), not a leveraged position

Mathematical representation: The expected return of a portfolio on the CAL is: $E(R_p) = R_f + \frac{E(R_m) - R_f}{\sigma_m} \times \sigma_p$ Where:

• $R_f$ = risk-free rate
• $E(R_m)$ = expected return of market portfolio
• $\sigma_m$ = standard deviation of market portfolio
• $\sigma_p$ = standard deviation of portfolio

When borrowing at $R_f$ to invest more than 100% in the market portfolio, the portfolio's standard deviation ($\sigma_p$) exceeds the market portfolio's standard deviation ($\sigma_m$), placing it to the right on the CAL.