Series 7: 10.3.2 Alpha

10.3.2  Alpha

At each level of risk there exists a single portfolio that will achieve the highest expected level of return. Each of these optimal portfolios can be plotted on a graph, forming a curve said to be on an efficient frontier. The curve is plotted on a graph where the horizontal axis is units of risk (usually standard deviation), and the vertical axis is return. Investments on the efficient frontier offer the highest amount of expected return for the level of risk. Investments below the efficient frontier are not optimal, in that they offer too little return for the amount of risk: by moving directly north from the investment to the point of intersection with the efficient frontier, one finds an investment opportunity with the same amount of risk but higher expected return. The most efficient markets are typically thought to be ones that have the highest volu