CFA Practice Question

There are 294 practice questions for this study session.

CFA Practice Question

Which of the following is (are) true about the Capital Market Theory?

I. A portfolio that lies above the Security Market Line (SML) is underpriced.
II. The correlation between two portfolios on the SML equals +1.
III. Portfolios that lie on the Capital Market Line (CML) are as completely diversified as possible.
IV. Portfolios that lie on the SML are not necessarily completely diversified.
A. I, III and IV
B. I, II, III and IV
C. I, II and IV
Explanation: The Capital Market Line is a combination of the risk-free asset and the tangency portfolio that lies on the efficient frontier of risky assets. Hence, the CML consists entirely of efficient portfolios (and every single efficient portfolio must lie on the CML). Furthermore, all the portfolios that lie on the CML are perfectly positively correlated. The SML, on the other hand, plots the expected return of a security against its beta. CAPM then implies that the SML is a straight line with the intercept representing the risk-free rate. Every single investment security that is fairly priced must lie on the SML. Thus, not every portfolio that lies on the SML is an efficient portfolio or completely diversified.

User Contributed Comments 5

User Comment
Shelton true I, wrong II => A
volkovv Good question. Statement II fooled me, and I got it wrong. The correlation between two portfolios on CML equals to +1! but that is not true for SML.
steved333 Well put, I made the same mistake!
Poorvi ditto!
kplatis good question..
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