# CML/SML Question

How are the capital market line (CML) and the security market line (SML) similar? A) The CML and SML use the standard deviation as a risk measure. B) The market portfolio will plot directly on the CML and the SML. C) Individual securities that are priced in equilibrium will plot on the SML and CML. D) The CML and SML can be used to find the expected return of a portfolio.

I think A

I dont think it is A…SML is just the graph of the CAMP…which uses beta as its measure of risk I am going with D

B? nope. upon further thought, i think d too.

B is correct maket portfolio corresponds to the intersection of CML and efficient frontier; corresponds to beta = 1 on SML

B is correct. Market port. is the only port. that plots on CML. For SML, all efficient port. will plot on SML. Rm plots on SML and has a corresponding beta of 1. What I don’t understand is why is D wrong? Both CML and SML help us in finding the expected return of an asset/port.

DOH. gotta stick with the first answer!!

Why O Why is D wrong?!

You use the cml to choose your allocation between the mkt portfolio and the risk free investment.

But you also use it to find E®= Rf+((Rm-Rf)*(Std. dev. Port))/(std. dev. M). And for SML, E®= Rf+(Rm-Rf)*Beta

with the cml, though, the expected return depends on the individual investor’s risk tolerance. So you can have different expected returns for different investors. with the sml, we use beta, so we can determine the expected return for any security or portfolio and come up with the same answer.

I always remember: SML is CAPM for ONE security and then repeat that for all securities. It does not help you find a portfolio because you ignore correlations.

but if you take it very literally, which i also did, choice D can sound correct… you ARE finding out an expected return of the portfolio. it’s just that that portfolio is just some combination of the rf rate and the mkt portfolio.

mcpass Wrote: ------------------------------------------------------- > I always remember: SML is CAPM for ONE security > and then repeat that for all securities. It does > not help you find a portfolio because you ignore > correlations. Take a look at p. 362 CFAI text Volume 6. It clearly says that the equation “describes the expected returns on all assets AND portfolios, whether efficient or not”. Acc. to CAPM, all investors satisfy their investments needs by combining the risk free asset with the Market PORTFOLIO. So, what you get after the combination is a portfolio. So, SML can be used for both assets and portfolios.

If you take it very literally that’s true. Therefore… this one’s poorly worded. B is still better

cfasf1 Wrote: ------------------------------------------------------- > but if you take it very literally, which i also > did, choice D can sound correct… you ARE finding > out an expected return of the portfolio. it’s just > that that portfolio is just some combination of > the rf rate and the mkt portfolio. exactly! so i don’t understand why D is wrong. I re-read both the CML/SML passages 5 times from the CFAI text.

I think that the question should have said that the CML is used to find the E® of only efficient portfolios, whereas SML can be used to find the E® of any portfolio, whether efficient or not. That’s one of the differences betn. them. I think the question is really poorly worded.