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IAI Actuarial Core Principles · Economic Modelling · Capital Asset Pricing Model (CAPM)

Which statement correctly distinguishes the capital market line (CML) from the security market line (SML)?

The CML relates expected return to total risk (standard deviation) for efficient portfolios only, whereas the SML relates expected return to beta and holds for any individual asset or portfolio. Both start at the risk-free rate.

  1. AThe CML plots expected return against beta for all individual securities
  2. BThe SML plots expected return against standard deviation for efficient portfolios only
  3. CThe CML applies to efficient portfolios and uses total risk, while the SML applies to any asset and uses betaCorrect
  4. DBoth lines have the market risk premium as their slope when plotted against standard deviation
  5. The CML intercept is the market return and the SML intercept is zero

Explanation

The CML plots expected return against standard deviation and holds only for efficient portfolios. The SML plots expected return against beta and holds for every asset or portfolio. Both have intercept equal to the risk-free rate.

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