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FIN201 Investment Management
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FIN201 Investment Management
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Course Code: FIN201
University: Kaplan Business School
MyAssignmentHelp.com is not sponsored or endorsed by this college or university
Country: Australia
Question:
Explain and graphically depict how Security Market Line (SML) is different from Capital Market Line (CML). Identify and discuss the importance of minimum variance portfolios? Why CAPM equation might be more relevant than other equations when calculating required rate of return.
Answer:
The present study is based on evaluation advance concepts of investment portfolio management in order to gain an understanding for making better investment decisions. In the first part, the study will cover the difference between Security Market Line and Capital Market Line by considering proper graph and its interpretation. Further, discussion of minimum variance portfolio and its significance will be done by making use of relevant examples. In the last part of the study; relevancy of CAPM model will be discussed in comparison to another model available for computation of return on investment.
Difference between Security Market Line (SML) and Capital Market Line (CML)
The capital market line arises from the integration of free of risk asset and the market portfolio. Every point together with the CML has premium profiles of risk-return to the portfolio on the effective edge (Asness, Frazzini and Pedersen, 2012). Derivation of CML is held by drawing a tangent line from the point of intercept upon the efficient frontier till when the expected return is equivalent to the free of risk rate of return (Hodnett and Hsieh, 2012).
A line is put in use in the pricing approach of a capital asset to demonstrate the return rates for the efficient portfolio based on the free of risk rate of return and the risk level, i.e., standards deviation for a specified portfolio (Lee and Su, 2014).
The CML is stated to be top-notch to the efficient frontier, as it considers the addition of risk-free asset within the portfolio (Brown, 2012). The CAPM which stands for capital asset pricing model illustrates that essentially the market portfolio is the efficient frontier.
Formula: E(Ri) = RF + SDc×{E(RM)-RF}/SDm
In which the SDC refers to a portfolio standard deviation C return, while the SDM is regarded as a market-return standard deviation.
The line from RF to L is stated as capital market line
x=risk premium
y=risk
slope=x/y
y-intercept=RF
The security market line refers to the related graphical representation of the CAPM. It reflects the expected return rate of own security as a characteristic of structural and non-divisible risk (Painter, 2010). While using SML in portfolio management, it shows the opportunity cost of investments that means making an investment in the integration or market portfolio and asset free of risk (Avadhani, 2010). The SML’s Y-intercept is equivalent to the risk-free rate of interest. The SML slope is equivalent to the market risk premium and states the risk-return trade-off at the specified time.
Formula: E( Ri) = RF + bi×{E(RM)-RF}
In which the E (Ri) is regarded as an expected return of security, the risk-free rate is the RF, and the beta coefficient of security is abbreviated as bi, and the E (RM) means the expected market return.
beta=1.0 involves as risky as the market
Securities A and B are highly risky as compared to the market
Beta > 1.0
Security C has lower risk as compared to the market
Beta< 1.0
Under-priced
Expected return > required a return as per the CAPM
· lies above the SML
Overpriced
Expected return
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