CFA Practice Question

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CFA Practice Question

According to capital market theory, which of the following statements is true?

A. M is not efficient by itself. It must be combined with the risk-free asset.
B. Portfolios formed by borrowing at the risk-free rate and investing in M are less risky than M alone.
C. The Capital Market Line connects the zero-risk, zero-expected-return point with M.
D. A portfolio with 50% M and 50% risk-free asset will have 1/2 the risk of M.
Correct Answer: D

M is efficient; it lies on the EF. Borrowing portfolios are more risky because they have added financial risk (leverage). The CML goes to the RF, which dominates holding currency (zero risk, zero return).

User Contributed Comments 14

User Comment
mtcfa Why is C also not correct?
danlan C: zero risk, and expected return is risk free return. So C is not correct.
mtcfa Thanks.
dobrekone danlan: wrong
(zero risk, zero expected return) is (0, 0) on the risk return space.
chamad Portfolio M is not risk free so C is wrong.
hannovanwyk in reality risk free doesnt exist?even government bonds have some risk to it-although it's very low. so in reality D would not be correct but i assume we keep it hypothetical
TheHTrader I agree with danlan. Look at the graph, the point should be (Rf,0) not zero return but risk free return.
pb09 hannovanwyk, I agree in reality this doesn't/no longer exists. The "risk free asset" always referred to (US Treasuries), carries interest rate risk and I'd argue default risk as well (I don't believe it will BTW, just inflate away). So yeah, this is strictly theory. But it's occurred to me for quite some time now that all financial theory based on (Rf) will one day be revised in some way...
pb09 ...especially if/when the 30-year T-bond get's downgraded from "AAA" logic it could no longer be considered "risk-free"
michlam14 i got it correct by process of elimination, but why exactly half the risk?
bablig it is half the risk because the risk free asset's rsk is at 0. Hence, when you look at the formula for a portfolio risk, the only term that remains is the weighted risk of the risky asset.
The other terms become nullified.
johntan1979 The zero expected return point is an extension to the left of the risk free rate on the horizontal axis, which doesn't exist (negative sd). Therefore, C is wrong.
SWHY0104 Right statement for C should be CML starts at 0 for x-axis (risk), RFR for y-axis (expected return). Question is saying it starts at 0 for x-axis AND 0 for y-axis. That's why it's wrong.
khalifa92 C; the starting point is wrong because the start point is higher than 0 Return ( which is the risk-free asset return) and connecting it to M
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