Define the efficient frontier in portfolio theory.

• A. The set of portfolios that offer the highest expected return for a given level of risk
• B. The set of portfolios that offer the highest expected return for a given level of risk; optimal portfolios lie on the frontier
• C. The set of portfolios with zero risk
• D. A line representing decreased return with increased risk

Answer: (B)

The efficient frontier is the boundary of the set of feasible portfolios that shows the best trade-offs between risk and expected return. In risk–return space, it consists of portfolios for which you cannot find another portfolio with a higher expected return without also taking on more risk; equivalently, for every level of risk there is a portfolio on the frontier offering the maximum possible return. Any portfolio inside or below this boundary is suboptimal because you could increase return without increasing risk by moving to a frontier point. This concept captures the idea that optimal diversification yields the highest return attainable for each given level of risk, and the frontier is where those optimal portfolios lie; the other options don’t describe this boundary or the typical positive relationship between risk and potential return.