Corporate Financial Management - Security Market Line & Capital Market Line

Running Head: CORPORATE FINANCIAL MANAGEMENT
CORPORATE FINANCIAL MANAGEMENT
Name of the Student
Name of the University
Author Note

1CORPORATE FINANCIAL MANAGEMENT
Table of Contents
Introduction................................................................................................................................2
Discussion..................................................................................................................................2
Security Market Line & Capital Market Line........................................................................2
Minimum Variance Portfolio Importance..............................................................................5
Relevancy of CAPM Equation...............................................................................................6
Conclusion..................................................................................................................................7
Reference....................................................................................................................................9

2CORPORATE FINANCIAL MANAGEMENT
Introduction
The management of corporate finance is the act or way of developing plans and
making investment decisions, which affects the operations of business positively. It is
consists of goals and plan setting for achieving it and then deciding best possible way for
paying them. In this concern, capital budgeting is defined as the formal process that entity
uses to evaluate potential expenditures or investments. It is related with decisions regarding
current funds (Lee & Su, 2014). Therefore, this report includes the discussion regarding the
way SML differs from CML. Further, discussion will be on MVP importance and lastly,
relevancy of CAPM equation will be discussed.
Discussion
Security Market Line & Capital Market Line
CML
CML is graphically depicted line. This line represents linear relationship in between
total amount of risk and expected return for efficient portfolios of risky as well as riskless
securities. It is graphically representation of the expected return of the portfolios that is
comprised of all the possible proportion between risk-free asset and market portfolios. There
is complete diversification, carries only the systematic risk and expected market return is
equal to expected return of the of market portfolio (Williams & Dobelman, 2017). Generally,
the calculation of expected return of particular portfolio is done by following formula:
“E(Rc) = y × E(RM) + (1 – y) × RF”
In this y is the market portfolio proportion, “E(RM)” is “market portfolio’s expected
return”, “(1-y)” is “risk-free asset’s proportion” and “Rf” is “risk free rate”. The return of
non-leveraged portfolios can be equal or less than market return, but leveraged portfolio’s

3CORPORATE FINANCIAL MANAGEMENT
return can significantly increase the return of market (Balteș & Dragoe 2017). The equation
of CML can be as follows:
E(Rc) = RF + SDc
E(RM) - RF
SDM
CML depicts all the possible portfolios combination that is comprised of various
proportions of portfolio of market and the risk-free market. The efficient frontier helps in
representing all the possible combinations of the efficient portfolios, consisting of only the
risky assets in the different proportions. CML’s intercept point and the efficient frontier calls
tangency or market portfolios. In case, if there is risk-averse or rational investor then higher
risk will be expected only in the situation when there is proportionate increase in the return. It
is from this particular standpoint, portfolio of tangency is considered to be the most efficient
portfolio (Hong & Sraer, 2016). CML is graphically depicted below: