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CFA Level I · CFA Level I Exam · Portfolio Risk and Return: Part II

The CML is based on total risk, while the security market line (SML) is based on systematic risk. Which of the following statements best describes a portfolio that plots below the CML?

A portfolio plotting below the CML offers less expected return per unit of total risk than the market portfolio, meaning its Sharpe ratio is lower. It is inefficient, typically because it bears unsystematic risk that diversification could remove.

  1. AIt is efficient but has high systematic risk only
  2. BIt offers less return per unit of total risk than the market portfolioCorrect
  3. CIt must contain only assets that plot below the SML

Explanation

Portfolios on the CML offer the maximum return per unit of total risk. A portfolio below it has a lower Sharpe ratio than the market portfolio, often because it holds diversifiable risk. It need not contain only assets below the SML, and it is not efficient.

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