Generally, securities that are fairly priced will plot on the CML / the SML. Securities that plot above the CML or the SML are generating returns that are too high for the given risk and are underpriced. Securities that plot below CML or the SML are generating returns that are too low for the given risk and are overpriced.
However, in the below question:
Why is the answer option C - unachievable?
Not a well worded question.
They need to specify that they’re talking about the ex-post CML, in which case the portfolio is unachievable because the CML is the SML with the highest Sharpe ratio; if that portfolio were achievable it would have a Sharpe ratio higher than the CML, which is impossible by definition.
If it’s an ex-ante CML, then an ex-post portfolio could plot above it; sometimes stocks perform better than expected (or so I’ve heard).
Sorry but can you explain what do you mean by ex-post CML? I did not understand what you meant to say…
You can create a CML based on expected performance (return and volatility), or on past performance. The former would be an ex-ante CML; the latter, an ex-post CML.
Thanks!!
My pleasure.
