Corporate Finance: SML and CML line, Minimum Variance Portfolio, CAPM Equation

Running Head: Corporate Finance
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Project Report: Corporate Finance

Running Head: Corporate Finance
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Contents
Introduction...........................................................................................................................................3
SML and CML line...............................................................................................................................3
Minimum variance portfolio..................................................................................................................7
CAPM equation.....................................................................................................................................9
Conclusion...........................................................................................................................................10
References...........................................................................................................................................11

Running Head: Corporate Finance
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Introduction:
Identifying the nature of the different corporate financial tools is crucial for the
financial analyst, financial managers and the investors. The different tools take the concern
on the different aspects of an investment and offer different result. It is necessary for the
related parties to identify the necessity and choose the better method accordingly. Such as,
minimum variance portfolio method is better when an investor wants to get lower risk, no
matter what would be the return from the investment. As well, the SML line is used to
represent the related risk position and return on the basis of risk. CAPM method is helpful for
the business and the investors to identify the expected rate of return from the business
(Damodaran, 2011).
In the report, the SML line, CML line, CAPM model and minimum variance portfolio
has been studied and it has been recognized that how an organization could identify the
different investment position of a stock with the help of these tools.
SML and CML line:
Security market line (SML) represents the result of CAPM equation in a graphical
manner. It basically represents the relations among the expected return of the stock and risk
of the stock which is represented in the beta factors. In different words, it could be said that
the security market line of a portfolio and stock represents the expected return which could be
expected from a particular stock or the portfolio against the different beta factors of that stock
or portfolio (Lee and Lee, 2006). The security line is basically based on the equation of
CAPM which is as follows:
E(Ri) = RF + βi × (E(RM) - RF)
The graphical representation of SML line has been presented on the basis of the below
case:
Beta Security
Market
Line: ri
Risk-
Free
Rate
Market
Return
0 5.00% 5% 8%
0.5 6.50% 5% 8%

Running Head: Corporate Finance
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1 8.00% 5% 8%
1.5 9.50% 5% 8%
2 11.00% 5% 8%
Figure 1: Security Market line
(Damodaran, 2011)
It represents that security market line only focuses on the beta factors of the stock and
the total expected return on the basis of that stock.
Further, capital market line (CML) represents the risk (in the manner of standards
deviation) against the return in a graphical manner. It basically represents the relations among
the expected return of an efficient portfolio and risk of the stock which is represented in the
standard deviation factors (Lumby and Jones, 2007). In different words, it could be said that
the capital market line of a portfolio represents the return which could be expected from a
particular portfolio against the different standard deviation level of that portfolio. The capital
line is basically based on the equation below equation: