The Capital Allocation Line – Introducing the Risk-free Asset

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The discussion of diversification benefits focused on a portfolio consisting of risky assets; when a risk-free asset is incorporated, diversification is still prevalent but a linear trade-off between risk and return is established.

The introduction of a risk-free asset does not change the construct of the minimum variance frontier graphical structure (y-axis = expected return; x-axis = standard deviation or variance).

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