Two questions:
Q1) Whats the difference between CAL,CML, SML and SCL lines?
I know CML is for total risk, uses Sharpe ratio and for Portfolio where as SML is for systematic risk, Beta and for security. Is this correct?
Q2) “All passive portfolios will lie on the kinked CML, although the investment in the risk-free asset may be positive (lending), zero (no lending or borrowing), or negative (borrowing).” CFAI book
What exactly does he statement mean by lending a risk free asset?
Thanks
Lending means investing in a risk-free asset (weight of risk free asset is positive).
From a graphical point, the point between the risk-free rate (std dev = 0) to point M (market portfolio) on the CML represents investment (i.e. lending) in risk-free asset. The point from M and above (on the CML) represents borrowing in risk free asset (weight of risk free asset is negative)
Three, actually.
A CAL (there’s a CAL for each asset) has standard deviation of returns on the horizontal axis and expected return on the vertical axis. For a given asset X, the CAL is the line running through the points (0, rrf) and (σX, E(RX)).
The CML (there’s only one) is the CAL with the highest Sharpe ratio; i.e., the steepest slope. The point where the CML is tangent to the efficient frontier is called the market portfolio (M).
The SML has β on the horizontal axis and expected return on the vertical axis; it’s the line running through the points (0, rrf) and (1, E(RX)). Note that 1 = βM.
The SCL for a given asset X has the market’s returns on the horizontal axis and asset X’s returns on the vertical axis; the SCL is the least-squares, best fit regression line through the return data. It’s slope is βX, and its intercept is αX.
You can plot portfolios against the SML if you want, and individual securities against the CML. Apart from that, you’re correct.
Buying risk-free bonds.
(You’re welcome)3/2.