Answer-first summary for fast verification
Answer: The capital market line always has a positive slope and its steepness depends on the market risk premium and the volatility of the market portfolio.
The capital market line connects the risk-free asset with the market portfolio, which is the efficient portfolio at which the capital market line is tangent to the efficient frontier. The equation of the capital market line is: \[\bar{R}_e = R_f + \left( \frac{\bar{R}_M - R_f}{\sigma_M} \right) * \sigma_e\] where the subscript e denotes an efficient portfolio. Since the shape of the efficient frontier is dictated by the market risk premium, (\bar{R}_M - R_f), and the volatility of the market, the slope of the capital market line will also be dependent on these two factors. **Key Points:** - The capital market line always has a positive slope because investors require higher returns for taking on more risk - The slope depends on the market risk premium (expected market return minus risk-free rate) and market volatility - Option B is incorrect because the CML connects the risk-free asset with the market portfolio, not the zero beta portfolio - Option C is incorrect because investors with low risk aversion would hold portfolios with higher risk/return, not the minimum variance portfolio - Option D is incorrect because under CAPM assumptions, all investors hold the same market portfolio regardless of individual forecasts
Author: LeetQuiz Editorial Team
Ultimate access to all questions.
Two risk analysts are discussing the efficient frontier following a presentation on the different measures of financial risk. According to the CAPM, which of the following statements is correct with respect to the efficient frontier?
A
The capital market line always has a positive slope and its steepness depends on the market risk premium and the volatility of the market portfolio.
B
The capital market line is the straight line connecting the risk-free asset with the zero beta minimum variance portfolio.
C
Investors with the lowest risk aversion will typically hold the portfolio of risky assets that has the lowest standard deviation on the efficient frontier.
D
The efficient frontier allows different individuals to have different portfolios of risky assets based upon their individual forecasts for asset returns.
No comments yet.