Question

In the following table, indicate whether each statement refers to the Capital Market Line (CML) or to the Security Market Line (SML). Capital Market Line (CML) Security Market Line (SML) Statement This line defines the linear relationship between the expected return on an efficient portfolio and its standard deviation The slope of this line, th risk. - TRP/OM, reflects the investors' aggregated, or market-level, expected premium for This line describes the return on an individual security as the sum of the risk-free rate and a premium for the security's nondiversifiable risk, which is the product of the stock's beta and the market's risk premium. If an investor wants to hold an efficient portfolio that offers an expected return of 9%, should the investor select portfolio A that exhibits a standard deviation of 5% or portfolio C that has a standard deviation of 4%? (Assume that both the portfolios offer an expected return of 9%) The investor should select portfolio C. The rational Investor will be indifferent about the portfolio selection. The investor should select portfolio A. True or False: Under the assumptions of the CML, the market portfolio's risk is measured by the standard deviation, whereas the risk component in the SML is measured by the beta coefficient. False True

Answer 1

Answer-

Capital market line (CML) is the graph plotted between the required return and risk measured by standard deviation of a portfolio of a risk-free asset and a portfolio of risky assets that can give the best risk-return trade-off.

Security market line (SML) is the graphical representation of the Capital Asset Pricing Model (CAPM) which gives the expected return of the market at different levels of systematic or market risk which cannot be diversified. It shows that the relationship between risk and return is linear for individual securities.

Statements

This line defines the --------------- and its standard deviation. ---------------------------- Capital Market Line (CML)

The slope of this line ------------- expected premium for risk ------------------------------ Capital Market Line (CML)

This line describes the return on an ---------- beta and market's risk premium ------- Security Market Line (SML)

Answer

The investor should select portfolio C as it gives the expected return of 9 % for a lower standard deviation of 4 %. As the expected return is same but portfolio C has a lower standard deviation of 4 % which is a measure of risk compared to the standard deviation of 5 % by portfolio A.

Answer

The statement is True as in CML the risk is measured by standard deviation and in case of SML the risk is measured by beta coefficient.