CFA Practice Question

CFA Practice Question

Which of the following is (are) true about the capital market theory?

I. A portfolio that lies on the security market line (SML) must lie on the capital market line (CML).
II. A portfolio that lies on the CML must lie on the SML.
III. Only efficient portfolios lie on the CML.
IV. Only efficient portfolios lie on the SML.
A. II and III
B. I and III
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. As such, it lies on the plane where expected returns are plotted against the standard deviation. Hence, the CML consists entirely of efficient portfolios (and every single efficient portfolio must lie on the CML). The SML, on the other hand, plots the expected return of a security against its beta. The CAPM 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 and hence, does not necessarily lie on the CML. However, every portfolio that is on the CML must be on the SML.

User Contributed Comments 7

User Comment
Levon This is not true, there are portfolios on the CML that are ineffecient, i.e. at the "begining" of the line (or bottm of the "C") where portfolios are ineffecient becasue higher returns can be achieved with the same risk (above the lower half of the "c"/curve).
garachen The CML is a line. It is not the efficient frontier but is tangent to it. All portfolios on the CML are efficient
danlan Garachen, good comments. Efficient portfolio is not necessarily on the efficient frontier.
chuong SML is fit to efficient portfolios and individual asets which have fairly price while CML is only fit to effcient portfolios
moneyguy ...and this is useful HOW?
Lambo83 How can a portfolio that lies on the CML also lie on the SML when the SML consists of individual assets not portfolios. It's not comparing apples with apples.
harrybay If every single investment on the SML must be fairly priced, but not every portfolio on the SML is efficient, isn't it a contradiction? Fairly priced = efficient no?
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