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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. (2500 words)




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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 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).

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