Economics Risk And Return Questions Medium
The Capital Market Line (CML) is a graphical representation that depicts the relationship between the expected return and the risk of a portfolio that consists of a risk-free asset and a risky asset. It is derived from the combination of the risk-free rate of return and the efficient frontier, which represents the set of portfolios that offer the highest expected return for a given level of risk.
The CML is a straight line that starts at the risk-free rate of return and passes through the tangency point between the efficient frontier and the capital market line. This tangency point represents the optimal portfolio, which is the portfolio that offers the highest expected return for a given level of risk.
The slope of the CML represents the risk premium, which is the additional return that investors require for taking on additional risk. The steeper the slope, the higher the risk premium. The CML allows investors to assess the risk-return tradeoff and make informed decisions about their investment choices.
In summary, the Capital Market Line (CML) is a graphical representation that shows the relationship between the expected return and the risk of a portfolio that combines a risk-free asset and a risky asset. It helps investors understand the risk-return tradeoff and make optimal investment decisions.