Business, Legal & Accounting Glossary
A capital market line (CML) is a line intersecting returns on no-risk investments and returns on the entire market. The difference between the capital market line and the efficient frontier is that the capital market line includes no-risk investments. All portfolios along the capital market line are efficient portfolios.
The 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.
The 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. The capital market line describes rates of return for efficient portfolios that are dependent on the level of risk and the risk-free rate of return for a specific portfolio. CML originates from the assumption that all investors will possess a market portfolio. Quantum of risk is positively correlated to the expected return. Thus, the equation representing an expected return is as follows:
Expected return= portfolio beta + risk-free rate
The capital market line is deduced by drawing a tangent line that starts from the intercept point located on the efficient frontier and extends to the point where expected return matches the risk-free rate of return. The 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 the efficient frontier.
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 the extra risk.
The 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 the characteristic line’s slope and standard deviation of returns of the specific asset. The slope of the characteristic line is typified by the asset’s beta. The slope ascertains risk-return trade-off. A greater risk is matched by greater returns.
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.
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This glossary post was last updated: 26th March, 2020 | 14 Views.