IAI Actuarial Core Principles · Economic Modelling · Capital Asset Pricing Model (CAPM)
The risk-free rate is 6% and the market portfolio has expected return 12% and standard deviation 15%. An efficient portfolio on the Capital Market Line has standard deviation 20%. What is its expected return?
The expected return is 14%. The CML slope is (12% minus 6%) divided by 15%, which is 0.4. Adding 0.4 times 20% to the risk-free rate of 6% gives 14%.
- A14%
- B16%Correct
- C18%
- D20%
- 12%
Explanation
The CML slope is (12% - 6%)/15% = 0.4. Expected return = 6% + 0.4 x 20% = 14%. Check: 20/15 = 1.333 of market, so the excess return is 1.333 x 6% = 8%, giving 14%. Option 16% is wrong.
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