1. With the aid of diagrams, show the difference between capital market line and security market...

1. With the aid of diagrams, show the difference between capital market line and security market line.

Expert Solution

Difference Between Capital Market Line (CML) and Security Market Line (SML)

1. The Capital Market Line (CML) is a line that is used to show the rates of return, which depends on risk-free rates of return and levels of risk for a specific portfolio. Security Market Line (SML) which is also called a Characteristic Line, is a graphical representation of the market’s risk and return at a given time.

2. The main differences between Capital Market Line and Security Market Line are how the risk factors are measured. In CML standard deviation is the measure of risk for, but in SML beta coefficient determines the risk factors of the SML. The Capital Market Line is considered to be superior when measuring the risk factors. The CML measures the risk through standard deviation, or through a total risk factor. On the other hand, the SML measures the risk through beta, which helps to find the security’s risk contribution for the portfolio.

3. Capital Market Line graphs only define efficient portfolios; but the Security Market Line graphs define both efficient and non-efficient portfolios.

4. Where the market portfolio and risk free assets are determined by the Capital Market Line, all security factors are determined by the Security Market Line.

5. While calculating the returns, the expected return of the portfolio for Capital Market Line is shown along the Y- axis. On the contrary, for SML, the return of the securities is shown along the Y-axis. The standard deviation of the portfolio is shown along the X-axis for CML, whereas, the Beta of security is shown along the X-axis for SML.

6. The market portfolio and risk free assets are determined by the Capital Market Line, all security factors are determined by the Security Market Line.

7. Unlike the Capital Market Line, the Security Market Line shows the expected returns of individual assets. The Capital Market Line determines the risk or return for efficient portfolios, and the Security Market Line demonstrates the risk or return for individual stocks.

jeff jeffy answered 2 years ago

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