Concept of Investment in Securities

Risk management
models of finance

1
RISK MANAGEMENT OF SECURITIES
Table of Contents
Introduction................................................................................................................................2
Concept of investment in securities...........................................................................................2
Analysis of CML approach........................................................................................................2
Concept of minimum variance portfolio................................................................................4
Importance of minimum variance portfolio...........................................................................4
Basic assumptions for CAPM model.........................................................................................5
Accuracy of CAPM model in the comparison of other models.............................................6
Concept of SML Approach....................................................................................................6
Special features of CAPM model...........................................................................................7
Importance of Beta.................................................................................................................8
Difference between CML and SML Lines.................................................................................9
Conclusion................................................................................................................................10
Recommendations for the investors.........................................................................................10
References................................................................................................................................12

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RISK MANAGEMENT OF SECURITIES
Introduction
In this report, an analysis will be done over the CML and SML approach of portfolios. These
are related to the risk and return measures for any portfolio related to investment. The various
characteristics of CAPM will also be discussed in order to understand the relationship
between risk free assets and expected return. The focus will be given over the difference
between SML and CML approach. The importance of efficient frontier and Beta is also
analysed in this report. The focus is provided on the importance of the various models and
approaches of the investments by getting maximum return on portfolios. In the end,
recommendations are given on the bases of the analysis of different approaches of investment
management for protecting the investors from high level of risk.
Concept of investment in securities
The investment in securities is seems to be risky for investors because no tool can exactly
predict the return of the security with a certain level of risk. Different models and approaches
of finance can provide an idea about the risk and return relationship for individual stocks or
portfolios. That is why most of the investors are interested in knowing the expected return
within a certain amount of risk. CAPM model, SML and CML approaches offers the
guidelines to measure risk and return relationship of different securities (VI OSAYI, 2019).
Analysis of CML approach
Capital market line is depicted by a graph with respect to expected return and risk of a
portfolio which is used by investors to obtain best return. The CML is calculated with the
help of market return on portfolio and risk free assets. In this approach risk is measured by
standard deviation.
The equation of CML is written below:
E(Rc) = Rf + SDc {E(Rm)- Rf/SDm}
E (Rc)= Expected return on portfolio C
SDc = Standard deviation for portfolio C
SDm= S.D. for market return

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RISK MANAGEMENT OF SECURITIES
E(Rm)= Expected market return
Rf = Risk free rate
Efficient frontier is defined as the set of the portfolios which offers optimal return for a
specified level of lowest risk with maximum expected return. The CML represents portfolios
that are optimal for the prefixed risk with maximum return. Where the efficient frontier and
CML intersects each other, that point represents the most efficient portfolio. This point is
usually depicted by ‘M’ in the graph (S Hundal, 2019). The following graph shows the CML
approach:
The X-axis of the graph is depicted by standard deviations and the Y-axis of the graph is
depicted by expected return on the security. The straight line is the CML line which is
associated with the expected return with a particular standard deviation after the measurement
of risk free assets.
Concept of minimum variance portfolios
The minimum variance portfolio is known as a good-diversified portfolio including all
individual risky assets with minimum possible risk for the return that is expected on a
particular security. These securities are properly hedged before trading in the market. Usually