PM Question

From a theoretical perspective, even though the assumption that investors can borrow and lend at the same (risk free) rate is violated, a straight-line CML can be constructed if: a) investors are risk neutral b) there are no transaction costs c) a zero-beta portfolio exists and yields more than RFR d) margin accounts are allowed


care to elaborate?

One of the key assumptions of the CML model is the equal borrowing and lending rate. (that determines at what point on the line you are and the slope of the line). In real world we can lend at RFR, but cannot borrow at that. This can be solved if there is a zero beta portfolio (i.e. not correlated with market). I believe Schweser has a nice explanation of this in the last section of SS12.