Capital market line
From Economypedia.com
A capital market line (CML) is a line intersecting returns on no-risk investments and returns on the entire market. The difference between capital market line and efficient frontier, is that the capital market line includes no-risk investments. All portfolios along the capital market line are efficient portfolios.
Capital market line is used to evaluate portfolio performance. Any point below any other point on the line will deliver lower returns but the same risk, and is therefore not ideal.
Capital market line is referred to as a measure employed to evaluate portfolio performance. Capital market line or CML is a graph employed in asset pricing models to depict rates of return in a market portfolio. Capital market line describes rates of return for efficient portfolios that are dependent on level of risk and risk free rate of return for a specific portfolio. CML originates from the assumption that all investors will possess market portfolio. Quantum of risk is positively correlated to the expected return.Thus, equation representing expected return is as follows:
Expected return= portfolio beta + risk-free rate
Capital market line is deduced by drawing a tangent line that starts from the intercept point located on efficient frontier and extends to the point where expected return matches risk free rate of return. Capital market line is believed to be a better measure than efficient frontier as it takes into consideration risk-free asset in a portfolio. All points on the CML have better risk-return profiles when compared to any portfolio located on efficient frontier.
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Capital asset pricing model
Capital asset pricing model (CAPM) is an economic model that is used for valuing stocks on relating expected return and risk. It is founded on the presumption that investors call for supplemental return if compelled to bear extra risk.
Characteristic line
Characteristic line is a line defined by utilizing regression analysis that sums up a specific security's or portfolios systematic risk and rate of return. The rate of return is subject to characteristic line's slope and standard deviation of returns of the specific asset. Slope of the characteristic line is typified by asset's beta. The slope ascertains risk-return trade-off. Greater risk is matched by greater returns.
Modern portfolio theory
Modern portfolio theory (MPT) also known as 'portfolio theory' or 'portfolio management theory' is an investment strategy that wishes to build an optimized portfolio that takes into account relationship between risk and return. MPT stresses that risk is implicit in better rewards. [4]
See also
- Arbitrage pricing theory
- Sortino ratio
- Sharpe ratio
- Expected returns
- Investment theory
- Efficient frontier
References
1. Investorwords entry on Capital market line. Retrieved on September 11, 2008.
2. Riskglossary entry on Capital market line. Retrieved on September 11, 2008.
3. Investopedia entry on Capital market line. Retrieved on September 11, 2008.
3. Investorwords entry on Capital market line. Retrieved on September 11, 2008.
Further reading
- Article in Riskglossary
