Difference Between Security Market Line

FIN201 Assignment, Trimester 1 2018
Investment management
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TABLE OF CONTENTS
Introduction................................................................................................................................4
Difference between Security Market Line (SML) and Capital Market Line (CML).................4
Importance of minimum variance portfolio...............................................................................8
Relevancy of CAPM in comparison to other equations...........................................................11
Conclusion................................................................................................................................13
References................................................................................................................................14

LIST OF FIGURES
Figure 1: Capital market line graph...........................................................................................4
Figure 2: Security market line....................................................................................................6
Figure 3: Frontier of Minimum variance portfolio....................................................................8
Figure 4: Capital asset pricing model.......................................................................................10

INTRODUCTION
The present study is based on evaluation advance concepts of investment portfolio
management in order to gain an understanding for making better investment decisions. In the
first part, the study will cover the difference between Security Market Line and Capital
Market Line by considering proper graph and its interpretation. Further, discussion of
minimum variance portfolio and its significance will be done by making use of relevant
examples. In the last part of the study; relevancy of CAPM model will be discussed in
comparison to another model available for computation of return on investment.
DIFFERENCE BETWEEN SECURITY MARKET LINE (SML)
AND CAPITAL MARKET LINE (CML)
The capital market line arises from the integration of free of risk asset and the market
portfolio. Every point together with the CML has premium profiles of risk-return to the
portfolio on the effective edge (Asness, Frazzini and Pedersen, 2012). Derivation of CML is
held by drawing a tangent line from the point of intercept upon the efficient frontier till when
the expected return is equivalent to the free of risk rate of return (Hodnett and Hsieh, 2012).
A line is put in use in the pricing approach of a capital asset to demonstrate the return rates
for the efficient portfolio based on the free of risk rate of return and the risk level, i.e.,
standards deviation for a specified portfolio (Lee and Su, 2014).
The CML is stated to be top-notch to the efficient frontier, as it considers the addition of risk-
free asset within the portfolio (Brown, 2012). The CAPM which stands for capital asset
pricing model illustrates that essentially the market portfolio is the efficient frontier.
Formula: E(Ri) = RF + SDc×{E(RM)-RF}/SDm
In which the SDC refers to a portfolio standard deviation C return, while the SDM is
regarded as a market-return standard deviation.