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Basic Question 7 of 10
The dominant line is the one that is tangent to the efficient frontier. All investors should target points along this line depending on their risk preferences. This line is referred to as the ______.
B. efficient frontier
C. capital market line
A. security market line
B. efficient frontier
C. capital market line
User Contributed Comments 7
| User | Comment |
|---|---|
| Aimy | why not A? |
| tony1973 | Because it is not. read the last part of the notes for this LOS about the comparison. |
| danlan | SML is not related to efficient frontier, CML is. |
| 0is4eva | The SML illustrates the risk-return relationship with the systematic covariance variable Cov(i,M) as the risk measure. Specifically, Cov(i,i) = s(i)^2 (standard deviation) so the variance of the Market portfolio is marked s(M)^2 on the x-axis. The CML illustrates the risk-return relationship with the standard deviation of the portfolio(s) on the x-axis and is plotted in the same diagram as the efficient frontier, the line is drawn through the tangent of the market portfolio M, whose standard deviation s(M) is plotted on the x-axis. SML - covariance of all portfolios with M. CML - standard deviation of all portfolios, also M. Both have E(R) on the y-axis. |
| danlan2 | SML has beta on the x-axis, CML has sigma on the x-axis. |
| charomano | CAL is the best allocation for each investor alone. The CML is what all investors agree it is best return, variance, and correlations. That's a CML is targeted by all investors depending on their risk preferences, or the weighting they prefer. |
| philjoe | it explicitly says in the notes that the CML also becomes the new efficient frontier since it dominates... |
I used your notes and passed ... highly recommended!
Lauren
Learning Outcome Statements
describe the implications of combining a risk-free asset with a portfolio of risky assets
explain the capital allocation line (CAL) and the capital market line (CML)
CFA® 2025 Level I Curriculum, Volume 2, Module 2.