Register / Login

CAPM & the SML

Premium

The Capital Asset Pricing Model (CAPM) assumes only one efficient portfolio, the market portfolio.
CAPM and the CML are more strict than simple Mean-Variance and the CAL.
CAPM and CAL similarities:
Risk averse investors.
Shared investor assumptions for expected returns, variances and standard deviations, and covariances of returns.
The above variables are the only inputs required to calculate the efficient frontier.
No taxes and no transaction costs.

CAPM additional assumptions:
All investors have the same CAL.
No restrictions for borrowing and lending at the risk free rate.
No restrictions on short-selling.
Trading volume does not change prices.

The CML is the efficient market portfolio, but the CAPM can describe the expected returns for all assets and portfolios.

CAPM: E(Ri) = RF + βi[E(RM) - RF]

E(Ri) = Return for asset "i"
RF = Risk-free rate of return
E(RM) = Expected return of the market portfolio
βi = The asset's beta
Beta is the asset's sensitivity to the return on the market portfolio
Beta is a measure of an asset's risk relative to market portfolio, as asset's with a beta above 1 are considered riskier than the market and beta's below 1 are considered less risky than the market.
β = Cov(Ri,RM)/σM2
Security Market Line (SML): Line produced by the CAPM equation for asset "i"
SMLs & Efficient Markets: In an efficient market securities are correctly priced when the expected risk and expected return equal the SML price of risk.

Unlock Premium Content

Upgrade your account to access the full article, downloads, and exercises.

You'll get access to:

Access complete tutorials and examples
Download source code and resources
Follow along with practical exercises
Get in-depth explanations

Previous Lesson

The Capital Market Line

Adding an Asset to a Portfolio – Improving the Minimum Variance Frontier

Portfolio Management

29 lessons

CFA Level 2: Portfolio Management – Introduction

Mean-Variance Analysis Assumptions

Expected Return and Variance for a Two Asset Portfolio

The Minimum Variance Frontier & Efficient Frontier

Diversification Benefits

The Capital Allocation Line – Introducing the Risk-free Asset

The Capital Market Line

Adding an Asset to a Portfolio – Improving the Minimum Variance Frontier

The Market Model for a Security’s Returns

Adjusted and Unadjusted Beta

Multifactor Models

Arbitrage Portfolio Theory (APT) – A Multifactor Macroeconomic Model

Risk Factors and Tracking Portfolios

Markowitz, MPT, and Market Efficiency

International Capital Market Integration

Domestic CAPM and Extended CAPM

Changes in Real Exchange Rates

International CAPM (ICAPM) - Beyond Extended CAPM

Measuring Currency Exposure

Company Stock Value Responses to Changes in Real Exchange Rates

ICAPM vs. Domestic CAPM

The J-Curve – Impact of Exchange Rate Changes on National Economies

Moving Exchange Rates and Equity Markets

Impacts of Market Segmentation on ICAPM

Justifying Active Portfolio Management

The Treynor-Black Model

Portfolio Management Process

The Investor Policy Statement

Topics

Financial Markets

Portfolio Management

Related Groups

Finance Concepts