Q3. The expected return on the Market Portfolio M is E(rM)=15%, the standard dev

Question

Q3. The expected return on the Market Portfolio M is E(rM)=15%, the standard deviation is ?M=25% and the risk-free rate is rf=5%. The CAPM is assumed to hold.

a) Draw on a diagram the Capital Market Line derived from the above data. Make sure to clarify the intercept and the slope.

b) Compute the expected return of two well-diversified portfolios (i.e. portfolios on the CML), one with st.dev of 18%, and the other with st.dev of 30%.

c) Suppose that a portfolio with a beta of 0.9 has an expected return of 15%. Is this compatible with the CAPM? Explain carefully.

Explanation / Answer

B) the expected return of two well-diversified portfolios (i.e. portfolios on the CML), one with st.dev of 18%, = Rf + (Rm-Rf)/?p *?M = 5 + (15-5)/18*25 = 18.89% and the other with st.dev

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