07 Dec
Security Market Line | Lambda | Capital Market Line | CA Final SFM
Risk, Return and Portfolio Theory
Security Market Line (SML)
When the expected rate of return as per CAPM is presented graphically it will be a straight line sloping upward. Such line is known as “Security Market Line” as explained below:
Lambda (λ)
Consider The Following Example
The above computed λ indicates that for each percent of market risk in the form of standard deviation, the risk premium should be 2.5%
Capital Market Line (CML)
When the expected rate of return is related to absolute risk of the stock, i.e. with the standard deviation, and presented graphically it will be a straight line sloping upward. Such line is known as “Capital Market Line” as explained below:
Or,
When CML is presented graphically, it also indicates a straight line sloping upward as explained below:
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