6/22/2021 0 Comments Difference Between Sml And Cml
The Capital Asset Pricing Model (CAPM) is an important part of portfolio theory that discusses the capital market line (CML) and security market line (SML).The following article offers a clear and simple understanding of what each CML and SML mean and outlines the similarities as differences between these two concepts.
The Y axis of the CML represents the expected return and X axis represents the standard deviation or level of risk. The CML is used in the CAPM model to show the return that can be obtained by investing in a risk free asset, and the increases in return as investments are made in more risky assets. The levels of return keep increasing as the risk undertaken increases. The CML, therefore, plays a part in assisting investors decide the proportion of their funds that should be invested in the different risky and risk free assets. Examples for risk free assets include treasury bills, bonds, and government issued securities, whereas risky assets can include shares, bonds, and any other security issued by a private organization. The Y axis represents the level of expected return, and the X axis shows the level of risk represented by beta. Any security that falls on the SML itself is considered to be valued fairly so that the level of risk corresponds to the level of return. Any security that lies above the SML is an undervalued security as it offers greater return for the risk incurred. Any security below the SML is overvalued as it offers less return for the given level of risk. Both CML and SML are important concepts in modern portfolio theory and are closely related to CAPM. The CML shows the level of risk and return for a portfolio of securities, whereas SML shows the level of risk and return for individual securities. The SML shows the level of risk for a given level of return.
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