8006 Exam Dumps | The transformation line has a y-intercept equal to

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Exam I: Finance Theory Financial Instruments Financial Markets - 2015 Edition
PRMIA.8006.v2021-04-25.q101
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Question 68/101

The transformation line has a y-intercept equal to

A. the expected portfolio standard deviation

B. the risk-free rate

C. the expected rate of return

D. zero

Correct Answer: B

Explanation
The transformation line represents the combination of a 'risky bundle' and the risk free asset. Investors can choose different combinations of these assets depending upon their risk appetite. The transformation line meets the y-axis (portfolio returns) at the point equal to the risk free rate. Choice 'b' is the correct answer and the rest are incorrect.The highest possible transformation line, ie the transformation line with the maximum slope, is the transformation line joining the risk free rate on the y-axis and the portfolio with the maximum Sharpe ratio on the efficient frontier. This line is called the 'capital markets line'. Investors can pick any point on this line according to their risk appetite, and doing so would maximize the return they can obtain for their desired level of risk. The capital markets line is tangential to the efficient frontier. The Sharpe ratio stays constant throughout the CML.

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