For some reason I cannot keep straight the difference between the CML, CAPM and SML…can someone explain why the answer is not A- CML?
The horizontal axis in the CML graph (the independent variable, the parameter) is total risk (i.e., standard deviation of returns). That is not the parameter in CAPM.
The horizontal axis in the SML graph (the independent variable, the parameter) is beta, which is the parameter in CAPM.
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The CML shows the relationship between risk and return of different portfolios.
The SML shows different levels of market/systematic risk of various marketable securities, plotted against the expected return of the entire market. And the CAPM describes the relationship between beta (market/systematic risk) and expected return.
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Thank you! So are the SML and CAPM one and the same? To me their equations are identical…
Thank you!
Yup.
YEs
CAPM is the equation of the SML
That’s true. The intercept on the graph is the first term of the CAPM equation /m- the risk free rate.
The slope of the line is the R(M) minus R(F) of CAPM.
The X axis is the Beta.
Thus, both are systematic risk based measures.