In the $10 million example, what percentage is allocated to risk-free investments?

• A. 40%
• B. 60%
• C. 20%
• D. 80%

Answer: (A)

Balancing risk and return by splitting the portfolio between risk-free and risky investments is the key idea. In the $10 million example, putting 40% into risk-free assets means $4 million is invested safely (zero significant risk), while the remaining 60%—$6 million—is placed in riskier assets with higher expected return but some volatility. This mix determines the overall portfolio return as a weighted blend: 0.4 of the risk-free rate plus 0.6 of the risky assets’ expected return. Since the risk-free portion adds no volatility, the portfolio’s risk comes from the 60% in risky assets. Choosing 40% reflects the intended balance between safety and growth in the scenario; a different percentage would shift the risk and return away from that target.