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Question 809 Markowitz portfolio theory, CAPM, Jensens alpha, CML, systematic and idiosyncratic risk

A graph of assets’ expected returns ##(\mu)## versus standard deviations ##(\sigma)## is given in the graph below. The CML is the capital market line.

Which of the following statements about this graph, Markowitz portfolio theory and the Capital Asset Pricing Model (CAPM) theory is NOT correct?

(a) The market portfolio M has systematic risk only. It’s a fully diversified portfolio comprised of all individual risky assets. The market portfolio is usually assumed to be the equity index, such as the ASX200 in Australia or the S&P500 in the US.

(b) The risk free security has no risk at all. Government bonds are usually assumed to be the risk-free security.

(c) Portfolio combinations of the market portfolio and risk free security will plot on the CML and will have systematic risk only. They will have no diversifiable risk.

(d) The portfolios on the CML with a return above ##r_f## have maximum return for any given level of risk.

(e) The individual assets and portfolios with returns less than the risk free rate are over-priced, have a negative Jensen’s alpha and should be sold.

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