Question

Consider two portfolios from the Capital Market Line (CML), A and B, given the following information:

Portfolio A: has an expected return of 10% and a standard deviation of 24%.

Portfolio B: has an expected return of 10.6% and a standard deviation of 26%.

a) Illustrate the CML, indicating portfolio A and B on CML.

b) What is the Sharpe ratio of portfolios located on the CML?

c) What is the risk-free rate?

d) Another portfolio, P, has an expected return of 9% and a standard deviation of 20%. Is this portfolio correctly priced?

Answer 1

a) Graph is there in the image

b) S= 0.3

c) Rf=2.8%

d) Standard deviation is 20%. Using CML, the expected return should be

R= 2.8% + (0.3 * 20%)=2.8%+6%= 8.8%

Hence, based on the risk in portfolio P, it should achieve a return of 8.8%. But the expected return of the portfolio is more than that. Hence, the portfolio is currently underpriced.

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