The Capital Market Line
On a graph, the Capital Allocation line (CAL) starts at the risk-free return and runs tangent to the minimum variance frontier for any group of risk assets.
On a graph, the Capital Market Line (CML) starts from the risk-free return on the y-int and runs tangent to the efficient frontier at the market portfolio.
Market Portfolio is portfolio representing the weighted value of all investible assets.
The idea is that all investors all investors agree to common expectations for all assets, i.e., expected returns, standard deviations and correlations. When there is only one sent of expectations there will be only one capital allocation line, called the Capital Market Line.
Since all the investors have the same expectations, they all are agreeing on similar composition of optimal risky portfolio, which is called the market portfolio.
The line equation for the CML is the same as the CAL and the slope coefficient is the Sharpe Ratio formula. CML is actually a special case of CAL.
Note that there is only one CML common for all investors, while there are unlimited CALs unique for each investor.
- 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
- CAPM & the SML
- 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