CFA Level I · CFA Level I Exam · Portfolio Risk and Return: Part II
The risk-free rate is 3%, the market portfolio has an expected return of 9% and a standard deviation of 15%. An investor wants a portfolio on the CML with a standard deviation of 20%. The expected return of this portfolio is closest to:
The expected return is about 11.0%. The CML slope is the market risk premium per unit of risk, 6% divided by 15%, or 0.40. Adding 0.40 times 20% to the 3% risk-free rate gives 11%, achieved by borrowing to invest more than 100% in the market.
- A10.0%
- B11.0%Correct
- C12.0%
Explanation
The CML slope is (9% − 3%)/15% = 0.40. Expected return = 3% + 0.40 × 20% = 11%. The portfolio is levered, with 133.3% in the market and −33.3% in the risk-free asset; check: 3% + 1.3333 × 6% = 11%.
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