from Schweser, book 4, page 131: “A straight CML (capital market line) allows risk to be separated into its systematic and unystematic components. Without an equal lending and borrowing rate, you cannot determine a security’s systematic risk, and , therefore, you cannot derive the SML. Without the SML, you cannot derive the CAPM.” Can someone please walk me through the logic here? What does the equality of the lending and borrowing rate have to do with determining a security’s systematic risk? I thought all of the risk on the CML was systematic anyway, since the investment is allocated between the risk free asset and the Portfolio M, which has only systematic risk. Thank you.
First : Systematic risk of a company is assessed by calculating its covariance with market portfolio. Second : Market portfolio lies at the point where CML is tangent to efficient frontier. Third : In case of different borrowing and lending rates… … CML truns into a curve and it touces efficient frontier at multiple points. (as explained by figure 5 on page 132 of Book 4 of Schweser) Fourth : We cannot identify market portfolio if CML is touching effiecient frontier at multiple points. Therefore, we cannot calculate systematic risk of a company.