Capital Market Line is a theoretical concept that represents all the portfolios that optimally combine the risk-free rate of return and the market portfolio of risky assets. Security Market Line measures the risk through beta, which helps to find the security’s risk contribution to the portfolio.
The differences between the capital market line and the security market line:
Capital market line:
- CML shows the tradeoff between expected return and total risk.
- CML considers both systematic and unsystematic risk.
- CML is the graphical presentation of the equilibrium relationship between expected return and total risk for efficiency diversified portfolios.
- The slope of the CML shows the market price of risk for efficient portfolios.
- The CML is a line that is used to show the rates of return, which depends on risk-free rates of return and levels of risk for a specific portfolio.
- Slope of the CML = (Rm – Rf) / σm
Security market line:
- SML shows the tradeoff between the required rate of return and systematic risk.
- SML considers only systematic risk.
- SML is the graphical presentation of CAPM.
- The slope of the SML shows the differences between the required rate of return on the market index and the risk-free rate.
- SML is a graphical representation of the market’s risk and returns at a given time.
- The slope of the SML = (Rm – Rf).