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CMA Final · Strategic Financial Management · Portfolio Theory and Practice

The risk-free rate is 6%. The market portfolio has an expected return of 14% and a standard deviation of 16%. An investor builds a portfolio on the Capital Market Line with a target standard deviation of 24%. What expected return does this portfolio offer, and what is the implied weight in the market portfolio?

The portfolio sits on the Capital Market Line, so the weight in the market is 24 divided by 16, which is 150%, financed by borrowing. Expected return is 6% plus 1.5 times the 8% market premium, giving 18%.

  1. A20% return; 150% in marketCorrect
  2. B18% return; 150% in market
  3. C20% return; 125% in market
  4. D18% return; 125% in market

Explanation

Weight in market = 24/16 = 1.5, so the investor borrows 50% at the risk-free rate. Return = 6 + 1.5 x (14 - 6) = 6 + 12 = 18%. Check by CML slope: market price of risk = 8/16 = 0.5 per unit; 6 + 0.5 x 24 = 18%. So the correct return is 18% with 150% in the market. Hence the correct choice is the 18% and 150% option.

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