- CFA Exams
- CFA Level I Exam
- Study Session 18. Portfolio Management (1)
- Reading 53. Portfolio Risk and Return: Part II
- Subject 3. The Capital Asset Pricing Model

###
**CFA Practice Question**

Both portfolio Y and Z are well-diversified. The risk-free rate is 6%, the expected return on the market is 15%, and the portfolios have the following characteristics:

Y | 17% | 1.20

Z | 14% | 1.00

Portfolio | Expected Return | Beta

Y | 17% | 1.20

Z | 14% | 1.00

Which of the following best characterizes the valuations of portfolio Y and Z?

A. Y is undervalued and Z is correctly valued.

B. Y is overvalued and Z is correctly valued.

C. Y is undervalued and Z is overvalued.

**Explanation:**Because both portfolios are completely diversified, their returns should only reflect the systematic risk of the portfolios. Thus, their betas are informative but their deviations are relevant. The required return for each portfolio can be calculated using the CAPM and compared with the associated market-implied expected return.

Y is undervalued. Its CAPM return is 6 + 1.2 x (15 - 6) = 16.8%, yet it has an expected return of 17%. Thus, the portfolio offers more return than is required given its level of risk; it would therefore be attractive to investors. In contrast, Z is overvalued. Its CAPM return is 6 + 1.0 x (15 - 6) = 15%. However, it has an expected return of 14%. Thus, the portfolio offers less return than is required given its level of risk; it would therefore be unattractive to investors.

###
**User Contributed Comments**
6

User |
Comment |
---|---|

ericczhang |
The second calculation for CAPM is wrong. I.e. 6 + 1 x (15-6) = 6 + 11 = 17% Is there a way to alert the site administrators and get our money back? |

BHowell |
Eric, I would strongly encourage you to double check your math before requesting your money back - 15 - 6 is 9, not 11. |

dream007 |
hahaha |

makatang |
LOL! |

tjlbutler |
A closed mouth gathers no foot. |

141414 |
yeezus |