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Question:

George Reilly, CFA, manages the Ivy Foundation portfolio. The Ivy Foundation has a minimum acceptable return of 7%. The current risk- free rate is 6%. Reilly assumes that returns are normally distributed and wants to choose the optimal portfolio for the foundation. The best approach Reilly should take is to choose the portfolio that:

A maximizes the safety-first ratio.
explanation

Because the Ivy Foundation has a minimum acceptable return that is greater than the risk-free rate, the safety-first ratio is a more suitable criterion than the Sharpe ratio for choosing the optimal portfolio. Given a set of available portfolios, the one that maximizes the safety-first ratio will minimize the probability that the return will be less than the minimum acceptable return if we assume returns are normally distributed. This is the optimal portfolio. Minimizing standard deviation of returns could lead to choosing a portfolio with an expected return below Ivy Foundation's minimum acceptable return.

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