CML vs. SML: Know the Difference

By Shumaila Saeed || Published on February 22, 2024

CML (Capital Market Line) represents all portfolios that optimally combine risk and return for a given market portfolio, while SML (Security Market Line) shows the expected return of individual securities as related to market risk.

CML vs. SML

Key Differences

The CML represents the risk-return trade-off for efficient portfolios combining a risk-free asset and the market portfolio. The SML, by contrast, shows the expected return of individual securities as a function of their systematic, non-diversifiable risk.

Feb 22, 2024

CML focuses on the total risk of a portfolio, using standard deviation as a risk measure. SML deals with systematic risk, represented by beta, which measures a security's risk relative to the market.

Feb 22, 2024

Investors use the CML to determine the optimal risk-return combination for their portfolio. SML is used to assess whether a security is undervalued or overvalued based on its risk and expected return.

Feb 22, 2024

CML is based on the Capital Asset Pricing Model (CAPM) and includes the risk-free rate and market portfolio. SML also originates from CAPM and includes beta, the risk-free rate, and the market return.

Feb 22, 2024

In practical terms, CML helps in creating an efficient portfolio mix. SML is useful for pricing and selecting individual securities in a diversified portfolio.

Feb 22, 2024

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Comparison Chart

Focus

Entire efficient portfolios

Individual securities

Feb 22, 2024

Risk Measure

Total risk (standard deviation)

Systematic risk (beta)

Feb 22, 2024

Application

Optimal portfolio combination

Pricing and selection of securities

Feb 22, 2024

Basis

Risk-free rate and market portfolio

Beta, risk-free rate, market return

Feb 22, 2024

Investment Strategy

Creating an efficient mix of assets

Evaluating the performance of individual assets

Feb 22, 2024

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CML and SML Definitions

CML

Uses standard deviation for risk assessment.

CML focuses on the total risk of the portfolio, as measured by standard deviation.

Jan 18, 2024

SML

Shows risk relative to the market.

SML uses beta to compare a security's risk to that of the market.

Jan 18, 2024

CML

Aids investors in portfolio allocation.

Investors use the CML to determine the best risk-return trade-off.

Jan 18, 2024

SML

Helps in assessing over or undervalued securities.

Using SML to determine if a security is priced correctly.

Jan 18, 2024

CML

Represents portfolios with the best risk-return balance.

Using the CML to identify the optimal investment portfolio.

Jan 18, 2024

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SML

Assists in making informed investment choices.

Investors refer to SML for sound investment decisions.

Jan 18, 2024

CML

Involves risk-free assets and market portfolio.

The CML shows how to combine risk-free assets with the market portfolio.

Jan 18, 2024

SML

Indicates expected return of individual securities.

The SML is used to assess the expected performance of a stock.

Jan 18, 2024

CML

Extends beyond the efficient frontier.

CML extends the efficient frontier to include a risk-free asset.

Jan 18, 2024

SML

Links return to systematic risk.

SML relates a stock's return to its market risk.

Jan 18, 2024

Repeatedly Asked Queries

What is CML?

CML stands for Capital Market Line, representing optimal risk-return portfolios.

Feb 22, 2024

How is CML used by investors?

Investors use CML to determine the optimal risk-return mix in their portfolios.

Feb 22, 2024

What risk measure does CML use?

CML uses total risk, measured by standard deviation.

Feb 22, 2024

What risk measure is used in SML?

SML uses beta, which measures systematic risk.

Feb 22, 2024

Does SML apply to all securities?

SML applies to securities with different levels of systematic risk.

Feb 22, 2024

How does the market return affect SML?

Market return impacts the slope of the SML, influencing security valuation.

Feb 22, 2024

Is SML static or dynamic?

SML is dynamic, changing with market conditions and risk-free rate.

Feb 22, 2024

What is the role of the risk-free rate in CML?

The risk-free rate is a starting point on the CML, representing return without risk.

Feb 22, 2024

What does SML represent?

SML, or Security Market Line, shows expected returns of securities based on risk.

Feb 22, 2024

What does SML indicate about a security?

SML indicates whether a security is under or overvalued based on its risk.

Feb 22, 2024

What happens if a security is above the SML?

A security above the SML is considered undervalued.

Feb 22, 2024

Can CML change over time?

Yes, CML can shift based on changes in the market portfolio or risk-free rate.

Feb 22, 2024

How do changes in the economy affect CML?

Economic changes can shift the risk-free rate and market portfolio, affecting CML.

Feb 22, 2024

What types of portfolios are on the CML?

Portfolios on the CML are efficient portfolios combining market and risk-free assets.

Feb 22, 2024

Is CML relevant for individual stock analysis?

CML is more relevant for overall portfolio optimization.

Feb 22, 2024

How does CML relate to diversification?

CML assumes diversified portfolios minimizing unsystematic risk.

Feb 22, 2024

Can SML predict stock performance?

SML helps predict expected return based on systematic risk.

Feb 22, 2024

What does a point below the CML indicate?

A point below the CML indicates a less than optimal risk-return trade-off.

Feb 22, 2024

Is beta the only factor in SML?

Beta is the primary factor, but other market conditions also influence SML.

Feb 22, 2024

Can SML be used for bond evaluation?

SML is typically used for stocks, but the concept can be applied to bonds with adjustments.

Feb 22, 2024

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About Author

Written by

Shumaila Saeed, an expert content creator with 6 years of experience, specializes in distilling complex topics into easily digestible comparisons, shining a light on the nuances that both inform and educate readers with clarity and accuracy.

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