CFA Practice Question

There are 151 practice questions for this study session.

CFA Practice Question

Which of the following statements is incorrect with regards to the use of a security market line (SML) during the capital budgeting process?
A. Target projects in which expected returns plot below the SML, imply that there are similar risk projects in the market that are yielding a lower return than the targeted project.
B. Projects whose expected returns plot below the SML should be rejected.
C. Projects whose costs are lower than the present value of its cash flows will plot above the SML.
Explanation: The SML plots the best available returns that are possible for each level of risk. Hence, if the return from a targeted project is plotting below the SML, it would imply that there are projects available in the market that have the same level of risk as the targeted project, but yet they generate returns that are higher than that of the targeted project.

User Contributed Comments 6

User Comment
studyingcfa B is correct. Projects whose expected returns plot ABOVE the SML should NOT be rejected, because it would imply they are offering excess return.
ssradja The question is asking which one is incorrect. Hence A is the correct asnwer.
broadex What about C?
somk A is NOT incorrect. below SML imply that there are projects of similar risk and higher returns "AND" projects of similar risk and lower returns unless this project is at the very bottom.
gregsob2 A is correct, projects plotting under sml have similar risk and lower return, A & B are equivalent. C seems incorrect, but im not sure...
rjdelong somk is correct technically, you outsmarted the question though somk, nice work. I don't see how A & B are equivalent... B is true, projects below SML should be rejected, therefore the incorrect answer as we are looking for the false statement. On second glance the word IMPLY is used in the question and A doesn't work because the plotting of a point below the SML doesn't IMPLY there exist similar risk projects with LOWER return (there may be or there may not be as somk pointed out, but it's not IMPLIED).
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