Which of the following statements is CORRECT? A) The slope of the CML is ( _M − r_RF)/b_M. B) All portfolios that lie on the CML to the right of σ_M are inefficient. C) All portfolios that lie on the CML to the left of σ_M are inefficient. D) The slope of the CML is ( _M − r_RF)/σ_M. E) The Capital Market Line (CM L)is a curved line that connects the risk-free rate and the market portfolio.

Question

Quizplus · Accepted Answer

The slope of the CML is equal to the excess return of the market portfolio divided by its standard deviation, which can be written as (E(Rm) - rf)/σm. Using the equation for the Sharpe Ratio, we can rewrite this as (E(Rm) - rf)/σm = (E(Rm) - rf)/(b x σ(Rm)). Simplifying, we get (E(Rm) - rf)/σ(Rm) x (1/b), which is equal to (E(Rm) - rf)/σ(Rm) x (MS/RS). Therefore, the slope of the CML is (E(Rm) - rf)/σ(Rm) x (MS/RS), where MS is the expected return on the tangent portfolio and RS is its standard deviation. Using the formula for the tangent portfolio, MS = [E(Rm) - rf]/σ(Rm) x σ(p) and RS = σ(p), where p is the tangent portfolio. Substituting these into the equation for the CML slope, we obtain (E(Rm) - rf)/σ(Rm) x (σ(p)/[E(Rm) - rf]/σ(Rm) x σ(p)) = (E(Rm) - rf)/σ(Rm). Therefore, the correct statement is D, which gives the equation for the slope of the CML.

Which of the Following Statements Is CORRECT