Comparative Analysis of Security Market Line and Capital Market Line

FIN200

Table of Contents
Security Market Line vs. Capital Market Line...........................................................................1
Importance of Minimum Variance Portfolios.............................................................................3
Relevance of CAPM equation.......................................................................................................5
References.......................................................................................................................................8

Table of Figures
Figure 1: Security Market Line........................................................................................................1
Figure 2: Capital Market Line.........................................................................................................2
Figure 3: Minimum Variance Portfolio...........................................................................................3
Figure 4: CAPM vs. WACC............................................................................................................6

Introduction
The present report aims to conduct comparative analysis of security market line and capital
market line to identify differences among these two approaches by using appropriate graphs.
Further, this considers the meaning, importance and relevance of the minimum variance portfolio
for investors. Last part of the study describes the relevance of capital asset pricing model for
evaluation of securities.
Security Market Line vs Capital Market Line
The Security Market Line (SML) is a graphical portrayal of the capital asset pricing model, i.e.
CAPM. It represents the relationship between a security’s expected return and its risk gauged by
its beta coefficient. When utilized in portfolio management, this line denotes the opportunity cost
of an investment (Sharpe, 2017). The Y-axis (at point where beta is 0) of the SML and it is
equivalent to the risk-free rate of interest. SML’s slope is similar to the market premium risk and
shows the risk-return trade-off during a specific time.
SML: E (Ri) = Rf + ßim (E(Rm) – Rf)
Figure 1: Security Market Line
(Source: Sharpe, 2017)
If Beta = 1, then it means that securities are as risky as the market
If Beta > 1, then Securities A and B are riskier in comparison to the market
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