Finance | SML, CML and Minimum Variance Portfolio

Running head: FINANCE
Finance
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Author’s Note

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Table of Contents
Introduction................................................................................................................................2
Difference between SML and CML...........................................................................................2
Importance of Minimum Variance Portfolio..............................................................................6
Reason for more Relevance of CAPM Equation than other Equations.....................................7
Conclusion................................................................................................................................10
References................................................................................................................................11

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Introduction
The overall objective of this report is divided into three parts. The aim of the first part
of the report is the analysis is the determination of the differences between Security Market
Line (SML) and Capital Market Line (CML) that are used by the investors for developing
portfolios. The second part of this report involves in the identification as well as discussion of
the importance of minimum variance portfolio. The last part of the report focuses on
discussing the reasons why the equation of CAPM might be more relevant than other
equations for the calculation of required rate of return.
Difference between SML and CML
Figure 1: Efficient Frontier
(Source: Calvo, Ivorra and Liern 2016)
Figure 1 depicts the options of the investors either investing in A and B point or in B
and C point. It also depicts that the investors would prefer to invest in B and C point. The
main reason for this is the greater return on stock C as compared to stock A despite of the
presence of same amount of risk. This would contribute to the investment in C (Lee and Su
2014).

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Figure 2: CML
(Source: Bajpai and Sharma 2015)
Both the risk factors and non-risk factors require to taken into account by the
investors while developing portfolio. Figure 2 denotes CML that is a straight line and RfS’
represents this line. Assets that are free from risks are denoted by the line and risky
investments and borrowing portfolios can be seen in the line starting from S to S’. Therefore,
it is evident from this that the CML shows a linear relationship between the required rate
associated with the efficient portfolio and the associated standard deviations. Revelation of
the risk price can be seen in the portfolio that CML denotes by the line slope. This makes the
standard deviation related with the portfolio same as the predicted return beyond the risk free
rate (Hong and Sraer 2016).
However, in case of SML, the efficient portfolio and the SML that CML measures
denotes the risk that is not possible to be reflected in CML. This leads to major difficulty in
assessing the connotation between the risk and return. Major involvement of SML could be
seen in measuring individual stocks notwithstanding the level of efficiency associated with
them. Moreover, the projected return for the beta of a stock id ascertained by SML which