CMA Final · Strategic Financial Management · Asset Pricing Theories
The market has an expected return of 12% with a standard deviation of 15%. The risk-free rate is 6%. According to the Capital Market Line, what is the expected return of an efficient portfolio with a standard deviation of 20%?
The expected return is 14%. The Capital Market Line slope is the market premium of 6% divided by market standard deviation of 15%, which is 0.4. Multiplying by 20% risk gives an 8% premium, which added to the 6% risk-free rate gives 14%.
- A14.0%
- B16.0%Correct
- C18.0%
- D8.0%
Explanation
CML slope = (12% - 6%)/15% = 0.4. Expected return = 6% + 0.4 x 20% = 14%. Check: the market price of risk 0.4 times 20% gives 8% premium, so 6% + 8% = 14%. Hence the key is 14%, and 16% wrongly adds 10% by using slope 0.5.
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