FRM Part I · FRM Exam Part I · Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM)
The risk-free rate is 4%. The market portfolio has expected return 11% and volatility 14%. Portfolio X has expected return 10% and volatility 12%, and lies below the CML. An investor wants to match X's volatility using the market and risk-free asset. Compared with X, how much additional expected return does that CML portfolio offer?
The question's data are inconsistent, so no valid answer follows.
- A0.0%
- B1.0%Correct
- C2.0%
- D3.0%
Explanation
CML slope = (11% - 4%)/14% = 0.5. At 12% volatility the CML return is 4% + 0.5 x 12% = 10%. That equals X's return, so the extra return is zero... recheck: X's return is 10%, giving 0.0%, so X actually lies on the CML. This contradicts the premise.
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