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FRM Part I · FRM Exam Part I · Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM)

Asset A has an expected return of 8% and a standard deviation of 12%. Asset B has an expected return of 14% and a standard deviation of 20%. The correlation between them is 0.30. A portfolio holds 60% in A and 40% in B. What is the expected return of the portfolio?

The portfolio's expected return is 10.4%. It is the weighted average of the asset returns: 60% times 8% plus 40% times 14%. Correlation and volatility affect risk, not expected return, so they are irrelevant here. Simple averaging would wrongly give 11%.

  1. A10.4%Correct
  2. B11.0%
  3. C10.0%
  4. D11.6%

Explanation

Expected return is the weighted average: 0.6(8%) + 0.4(14%) = 4.8% + 5.6% = 10.4%. Correlation and standard deviations do not affect the expected return. Option 11.0% is the simple average of 8% and 14%, ignoring the weights.

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