Capital Market Line and Security Market Line (SML) in Finance
VerifiedAdded on  2024/04/23
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AI Summary
This report provides an overview of the Capital Market Line (CML) and the Security Market Line (SML), two essential concepts in finance for understanding and evaluating investment opportunities. The CML illustrates the risk-return tradeoff for diversified asset portfolios, depicting the optimal combination of risk-free and risky assets. It starts at the risk-free rate and slopes upward, reflecting the market risk premium. The SML, derived from the Capital Asset Pricing Model (CAPM), represents the relationship between expected return and systematic risk (beta) of individual assets. Assets with higher betas should offer higher expected returns. The SML intersects the y-axis at the risk-free rate and has a slope equal to the market risk premium. Both CML and SML guide investment decisions, with the CML helping determine asset allocation and the SML providing a framework for evaluating individual assets based on risk-adjusted returns. Investors can construct well-diversified portfolios that balance risk and return effectively by applying these concepts.