Elements of the Model

The capital asset pricing model consists of two elements: the capital market line (CML) and the security market line (SML).The capital market line, as discussed before, represents the efficient frontier formed by combining one-month T-bills with a broad index of common stocks. Its serves to functions. First, it depicts. the risk-return relationship for efficient portfolios available to investors. Second, it shows that the appropriate measure of risk for an efficient portfolio is the standard deviation of return on the portfolio. The security market line, on the other hand, pertains to all portfolios (which plot on and below CML as well as individual securities, This makes CML a special case of SML. We explore below SML and its implications in detail.

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