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IAI Actuarial Core Principles · Economic Modelling · Capital Asset Pricing Model (CAPM)

On the Capital Market Line, an investor puts Rs 60,000 in the market portfolio and Rs 40,000 in the risk-free asset. The risk-free rate is 5%, the market expected return is 11% and market standard deviation is 10%. What are the expected return and standard deviation of the investor's portfolio?

The portfolio has expected return 8.6% and standard deviation 6%. The return is the weighted average 0.6 times 11% plus 0.4 times 5%, and the risk is just 0.6 times the market's 10%, because the risk-free asset adds no variance.

  1. A8.6% and 6%Correct
  2. B6.6% and 10%
  3. C8.6% and 10%
  4. D9.4% and 6%
  5. 11% and 6%

Explanation

Expected return = 0.6 x 11% + 0.4 x 5% = 6.6% + 2% = 8.6%. Standard deviation = 0.6 x 10% = 6%, as the risk-free asset has zero variance and zero covariance. Check against CML: 5% + 0.6 x 6% = 8.6%.

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