International Review of Economics & Finance

Running head: FINANCIAL ACCOUNTING
Financial Accounting
Name of the Student
Name of the University
Author Note

FINANCIAL ACCOUNTING1
Table of Contents
Introduction................................................................................................................................2
Discussion..................................................................................................................................2
Security Market Line versus Capital Market Line.................................................................2
Importance of Minimum Variance Portfolios........................................................................5
CAPM Relevance for Required Rate of Return.....................................................................7
Conclusion..................................................................................................................................9
References................................................................................................................................10

FINANCIAL ACCOUNTING2
Introduction
Company uses several management techniques in financial management. Financial
management is not complete without the reference of modern portfolio theory that efficiently
constructs the investor’s portfolio (Elterich 2014). The report aims to underline portfolio
theories through the theory of CAPM and its related concepts. The theory manages the risk
and returns factors related to the portfolio as per the scenario of the market. Capital Asset
Pricing Model (CAPM) is a model that is highly used in the field of investment management.
The report has discussed regarding the efficient portfolios in which Minimum Variance
Portfolios determines to provide with an expected level of return through minimum risk that
is positioned through the diversified portfolio (Rutterford and Sotiropoulos 2016). Markowitz
suggests the investor that they can reduce the risk of loss by diversifying and allocating their
assets of investment with a proper quantitative technique (Chen 2016). The discussion cannot
be completed without the reference of the Security market line, which represents CAPM
graphically, and Capital market line that reflects a proficient portfolio and Minimum variance
portfolios graphically. All of these form a pillar of financial and investment management in
which it embraces major importance in making decisions related to the investment.
Discussion
Security Market Line versus Capital Market Line
SML or Security Market Line is the graphical demonstration of CAPM that seeks to
present the level of market risk based on an assumption of a perfect market. SML estimates
the expected return by assuming that risk and return are proceeding in the same direction
(Jylha 2014). Thus, the investors who prefer a risk-averse condition used to choose the
investment nearby to the start of the line where the risk seems to be zero. On the other hand,
the investors who are risk-takers used to choose the investment to the uppermost point of the

FINANCIAL ACCOUNTING3
line, which represents a higher risk. The securities plotted above the SML are undervalued,
that means the risk-free rate undervalued because the expected return as compare to their risk
is low (De Giorgi, Post and Yalcin 2019). However, the securities below the SML are
overvalued due to their expected return, as compared to their risk is high.
The X-axis in the graph below represents the expected rate of return for security
within the market and Y-axis represents a beta of the security value, which measures the
security's systematic risk. This signifies that risk cannot be expanded or diversified. SML
presents essential information of several securities under a single graph that can be easily
comparable for taking decisions. The equation for SML is as:
SML = E (Ri) = Rf + βi [E (RM) – Rf]
(Security Market Line)