What makes the "efficient frontier" efficient?

The concept of the "efficient frontier" in modern portfolio theory is centered around the idea of maximizing return for a given level of risk or minimizing risk for a given level of expected return. The efficient frontier represents a set of optimal portfolios that offer the highest expected return for a defined level of risk.

Choosing the option that states it maximizes the ratio of expected return to risk captures this essence perfectly. The efficient frontier is constructed by identifying portfolios that provide the most favorable return per unit of risk, which is often measured by standard deviation. Investment portfolios that lie on the efficient frontier demonstrate that the investor cannot achieve a higher expected return without increasing risk, making them the most effective choices for an investor seeking to balance risk and reward.

In contrast, other options do not fully encapsulate the definition of efficiency in this context. For example, simply minimizing risk does not necessarily mean maximizing return; a risk-averse investor might have portfolios that are too conservative. Similarly, maximizing expected return alone does not account for the risk involved, and a balanced portfolio may not reside on the efficient frontier unless the return-to-risk ratio is optimal. Therefore, the choice that emphasizes the maximization of the ratio of expected return to risk most accurately describes the efficiency characteristic of portfolios on the efficient