NASAA Series 65, Uniform Investment Adviser Law ExaminationClient Investment Recommendations and StrategiesMedium
A client has a portfolio valued at $1,000,000. The portfolio has a beta of 1.2, and the expected market return is 9%. The risk-free rate is 3%. According to the Capital Asset Pricing Model (CAPM), what is the expected return of this client's portfolio?
- A9.0%
- B13.2%
- C10.2%
- D10.8%
Show answer & explanationAnswer & explanation
Correct answer: D. 10.8%
The CAPM formula is: Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Plugging in the values: 3% + 1.2 * (9% - 3%) = 3% + 1.2 * 6% = 3% + 7.2% = 10.2%. The portfolio value of $1,000,000 is irrelevant for this calculation.
Why the other options are wrong
- A. This is the market return, not the portfolio's expected return.
- B. Incorrect calculation, possibly adding beta directly to market return.
- C. This is the correct calculation using the CAPM formula: 3% + 1.2 * (9%-3%) = 10.2%.
Capital Asset Pricing Model (CAPM)
A model that calculates the expected rate of return for an investment, given its risk-free rate, beta, and expected market return.
- Formula: E(Ri) = Rf + Beta * (E(Rm) - Rf).
- Beta measures systematic risk.
- Used to determine if an asset is undervalued or overvalued.
Memory trick: Risk-free plus beta times market minus risk-free.