Question

5. The Capital Market Line and the Security Market Line Aa Aa E 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, TM - PRF) / OM, reflects the investors' aggregated, or market-level, expected premium for risk. 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 10%, should the investor select portfolio A that exhibits a standard deviation of 3% or portfolio C that has a standard deviation of 8%? (Assume that both the portfolios offer an expected return of 10%.) The rational investor will be indifferent about the portfolio selection. The investor should select portfolio C. 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. O False True

Answer 1

1. CML - In CML, the risk is measured through standard deviation

2. CML - The slope is the slope of the CML line , while SML slope is measured through (Rm-Rf)

3. SML - It measure the risk through beta

An Efficient portfolio is the portfolio which either gives highest return for a given level of risk or lower level of risk for given level of expected return

Therefore The investor should Select Portfolio A.

In CML risk is measure using Standard Deviation while SML measures risk through beta

Answer is True