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CMA Final · Strategic Financial Management · Asset Pricing Theories

The market portfolio has a standard deviation of 15% and an expected return of 11%; the risk-free rate is 5%. An investor wants a portfolio on the Capital Market Line with total standard deviation of 24%. Using CML, what is the expected return of this portfolio, and what proportion is invested in the market portfolio?

Expected return is 14.6% with 160% invested in the market portfolio. The CML slope is 6% divided by 15%, which is 0.4, so return is 5% plus 0.4 times 24%. The weight is 24 divided by 15, financed by borrowing 60% at the risk-free rate.

  1. A14.6%; 160% in marketCorrect
  2. B15.0%; 150% in market
  3. C14.6%; 60% in market
  4. D12.6%; 160% in market

Explanation

CML slope = (11 - 5)/15 = 0.4. Expected return = 5 + 0.4 x 24 = 14.6%. Weight in market = 24/15 = 1.6 or 160%, financed by borrowing 60% at the risk-free rate. Check: 1.6 x 11 + (-0.6) x 5 = 17.6 - 3 = 14.6%. The option 60% confuses the borrowed amount with the market weight.

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