Question

Which of the following about the CML are true?

1. The capital market line is tangent to the efficient frontier.
2. As an investor moves away from the point of tangency toward the risk-free rate, the percentage of Treasury bills in the portfolio will increase.
3. As an investor moves away from the point of tangency toward the risk-free rate, the percentage of long-term bonds in the portfolio will increase.
4. The portfolio at the point of tangency includes an equal proportion of stocks and bonds.

Select one:
a. 1 and 2
b. 1 and 4
c. 2 and 3
d. 3 and 4

Answer 1

The capital market line (CML) is indeed tangent to the efficient frontier and when an investor moves towards the risk-free rate on the CML, the percentage of Treasury bills in the portfolio increases. Thus, statements 1 and 2 about the CML are true.

Step-by-step explanation:

Regarding the statements about the Capital Market Line (CML) and which are true, the correct selections are:

1. The capital market line is tangent to the efficient frontier.
2. As an investor moves away from the point of tangency toward the risk-free rate, the percentage of Treasury bills in the portfolio will increase.

The first statement correctly describes that the CML represents the optimal portfolio of risky assets and the risk-free asset. It is tangent to the efficient frontier at the point representing the market portfolio. As investors combine the market portfolio with the risk-free asset (like Treasury bills), they move along the CML. Therefore, as one moves closer to the risk-free rate on the CML, the proportion of Treasury bills in their portfolio does indeed increase, while the percentage of the market portfolio (which includes stocks, bonds, and other assets) decreases.

The correct answer is therefore 1 and 2. The statements regarding increases in long-term bonds and the portfolio at the point of tangency having equal proportions of stocks and bonds are not inherently true about the CML.