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FRM Part I · FRM Exam Part I · Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM)

Under two-fund separation in the CAPM with unrestricted riskless borrowing and lending, which statement is correct about two investors with different risk aversion?

Both investors hold the same risky portfolio, the tangency or market portfolio, and differ only in how much they place in the risk-free asset. Risk aversion changes the split between the riskless asset and the market portfolio, not the composition of the risky holdings.

  1. AThe more risk-averse investor holds a different mix of risky assets that has lower volatility
  2. BBoth hold the same risky-asset portfolio and differ only in the proportion held in the risk-free assetCorrect
  3. CThe less risk-averse investor holds only the minimum-variance portfolio
  4. DBoth must hold the same total weight in the risk-free asset

Explanation

With homogeneous expectations and a risk-free asset, every investor's optimal risky portfolio is the tangency (market) portfolio. Risk aversion determines only the split between the risk-free asset and the market portfolio. The first option is wrong because risk is adjusted via the risk-free weight, not the risky mix.

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