6.2 Capital Market Line

Question 1

The CML shows the …

Answer 1

optimal combination of efficient portfolios in equilibrium.

It is tangential to the efficient frontier of risky portfolios. Point of tangency –> sharpe ratio is highest (optimal risky portfolio)

Question 2

All investors will hold efficient portfolios along the efficient frontier, i.e.

Answer 2

from risk free asset to tangency portfolio

Question 3

As investors have homogenous expectations they hold a …: Tobin separation (only the mix between risky and safe asset is different according to preferences)

Answer 3

risky portfolio with an identical structure

Question 4

The concept of CML introduces equilibrium into portfolio theory: In order to have equilibrium on the capital market, …
* Therefore, the risky portfolio has to be the same as the …, i.e. the portfolio of all risky assets available in an economy
* The … is then the portfolio of all risky assets which is completely diversified

Answer 4

the tangency portfolio has to contain all assets

market portfolio

Question 5

For all efficient portfolios, the normalized risk premium is the same in equilibrium. Write the equations for the Sharpe ratio and equation of CML.

We can see that for all risk efficient portfolios, the Sharpe-ratio will be the same.

Answer 5

Expected return of certain portfolio = Risk free rate + Sharpe ratio * Standard deviation of certain portfolio.

Sharpe-ratio: (expected return of mkt portfolio - risk free rate) / standard deviation of market portfolio