I am having a hard time understanding the role of CAPM in portfolio. I get that the CAPM is the equasion for a line and that line is called the SML. What I am missing is…beyond that what is the relevance?
CAPM is not “the equation for a line.” It’s a pretty comprehensive model for creating optimal portfolios. As the name implies, you can also price assets with beta (which is the SML part).
I am ot sure what you mean by saying it s not an equation for a line. Strictly speaking that is exactly what it is
The risk free rate is the y intercept, beta is the slope, market risk premium is the x (the idependant variable)
CFAI page 406 simply says the name of the line is the SML. I understand it’s use in equity valuation but it’s use in portfolio is foggy.
Check out wikipedia. Efficient frontier, CAL, etc., it’s all a lot more comprehensive than just the SML.
Wikipedia if you have 6 months before the exam, for now, CAPM tells you what the minimum return for a stock (given all teh assumption) should be. If CAPM says the return is 12% but investors calculate the return to be 14% then that’s good, buy it. Without CAPM, you wouldn’t know if 12% was good or not.
thanks all. Dreary, i understand its use in evaluation of single assets like you describe. What i am mising is whyit is brought up again in portfolio. I have a good handle on what the book says about it and maybe i am just thinking about it too much…thinking it must be more complicated than it was.
it;s interesting to note though that in the final analysis the CAPM does not even work in the real world.
CAPM doesn’t work in the real world? Tell that to Markowitz.
Umm, Thats pretty much the point of reading 61. That if you relax 2 of the unealistic assumptions then all investors do not hold a combination of market portfoio and risk free asset, that, expected return and beta are not linear and the market portfolio may not in fact be efficiant