SML and market return

CFA Level I
#1

The risk-free rate is 5% and the expected market risk premium is 10%. A portfolio manager is projecting a return of 20% on a portfolio with a beta of 1.5. After adjusting for its systematic risk, this portfolio is expected to:

A) equal the market’s performance.

B) outperform the market

C) underperform the market

Based on the CAPM, the portfolio should earn: E® = 0.05 + 1.5(0.10) = 20%. On a risk-adjusted basis, this portfolio lies on the security market line (SML) and thus is earning a risk-adjusted rate of return equivalent to that of the market portfolio.

Why do we know it lies on the SML. When I saw this question I thought the 20% projected return was actually only the result on the CAPM. So if they say to us that there is a projection on return we can make see if it is under/over or equally valued as the required rate of return right??? what about that statement that we know it lies on the SML… because it is properly valued?? thank you

#2

I think that fact that its return is equal to its beta adjusted expected return means it’s on the sml. If it was above the sml, its expected return would be above the market expected return. The SML is just a graphical representation of CAPM. I think. I’m not that good at the PM section.

#3

I wrote an article on CAL vs. CML vs. SML: http://www.financialexamhelp123.com/cal-vs-cml-vs-sml/

(Full disclosure: as of 4/25/16 there is a charge to read the articles on my website. You can get an idea of the quality of the articles by looking at the free samples here: http://www.financialexamhelp123.com/sample-articles/.)

In short, the security plots above, on, or below the SML exactly as the expected return is greater than, equal to, or less than (respectively) the return derived from CAPM.