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# P1.T1.61. Capital market line (Elton & Gruber)

#### David Harper CFA FRM

##### David Harper CFA FRM
Staff member
Subscriber
AIMs: Describe the capital market line. Use the CAPM to calculate the expected return on an asset.

Questions:

61.1. Which of the following is a DIFFERENCE between the capital asset pricing model (CAPM) and the capital market line (CML)

a. The CML does not include the riskfree asset, but CAPM does
b. CAPM is a special case of the CML, where the portfolio is diversified and efficient
c. In CAPM, risk is systematic (beta) since it can apply to inefficient portfolios; but in CML, risk is total (volatility) since it only includes efficient portfolios
d. CAPM assumes the portfolio is diversified and efficient, but CML allows for un-diversified and/or inefficient portfolios

61.2. A security will produce only two cash flows: $100 at the end of the first year, and$100 at the end of the second year. The riskfree rate is 3.0% and the Market's expected return is 8.0%. The security's volatility is 24.0% and the Market's volatility is 15.0%; the correlation (rho) between the security and the Market is 0.70. Under the capital asset pricing model (CAPM) with annual discounting, what is the present value of the security?

a. $169.01 b.$176.87
c. $185.95 d.$191.35

61.3. During the most recent period, a Portfolio returned 10.3% when the Market return was only 8.0%. The riskfree rate was 2.0%. The Market's return was 8.0% with volatility of 29.0%. Finally, the covariance between the portfolio and Market was 0.134560. Under the CAPM, did the portfolio outperform?

a. No, Jensen's alpha is -1.30%
b. No, Jensen's alpha is -0.50%
c. Yes, Jensen's alpha is +0.50%
d. Yes, Jensen's alphs is +1.30%

Answers:

#### Deepak Chitnis

##### Active Member
Subscriber
Hi David,
Tried solving the question 61.3(also included in practice question). I have tried calculating the Jensen's alpha using Jensen's alpha's formula. Like,
(10.3%-2.0%)-1.6(8.00%-2.00%)=8.3%-6.96%=1.30%
So my question is that I am getting +1.30%, so am I suppose to use strictly the CAMP ?for this question(I think this is a very dump question but when I saw the question on question set, I saw the answers and tried to solve this with Jensen's alpha formula and also tell what to do in exam if there is question like this and not to confuse with it) . Sorry for trouble.
Thank you,

#### Dr. Jayanthi Sankaran

##### Well-Known Member
Hi Deepak,

Looks like you have a miscalculation. Jensen's alpha here is:

[10.3% - 2%] - 1.6[8.0% - 2.0%] = 8.3% - 9.6% = -1.30%

So, the answer is no the portfolio did not outperform. Hope that helps!

Thanks!
Jayanthi

#### Deepak Chitnis

##### Active Member
Subscriber
Ohh!!!!! Thank you so much Jayanthi Sankaran. I think Just missed something. That means we can even use Jensen's formula for this question. Thank uou.