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 20%. An investor can lend or borrow at the risk-free rate and wants a portfolio on the Capital Market Line with a standard deviation of 15%. What expected return will the portfolio offer?
The expected return is 12%. The Capital Market Line slope is the market risk premium of 8% divided by the market standard deviation of 20%, which is 0.4 per unit of risk. Adding 0.4 × 15 = 6% to the 6% risk-free rate gives 12%.
- A14%
- B10.5%
- C12%Correct
- D18%
Explanation
The CML slope = (14 − 6)/20 = 0.4. Expected return = 6 + 0.4 × 15 = 12%. Check: 75% in the market and 25% in the risk-free asset gives 0.75×14 + 0.25×6 = 12%. Option 10.5% is 75% of 14% with the risk-free portion ignored.
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