Two-Fund Separation Theorem

The two-fund separation theorem states that every investor will hold a combination of two portfolios or funds. These are represented by the optimal risky portfolio and:

Incorrect. Bonds may provide suitable diversification but are not one of the funds in the two-fund separation theorem.

Incorrect. Stocks are not specifically identified in the two-fund separation theorem.

Correct. The US Treasury bill is commonly considered the risk-free asset. According to the two-fund separation theorem, all investors, no matter their investment behaviors and risk preferences, will hold the risk-free asset and the optimal risky portfolio or the optimal portfolio of many risky assets.

bonds.

stocks.

US Treasury bills.