CML vs SML – Key Difference. SML and CML are two very crucial concepts in finance. SML stands for Security Market Line, while CML’s full form is Capital Market Line. Both SML and CML relate to risk and return on investment.
The CML is a line that is used to show the rates of return, which depends on risk-free rates of return and levels of risk for a specific portfolio.
SML, which is also called a Characteristic Line, is a graphical representation of the market’s risk and return at a given time.
What is Security Market Line?
The security market line (SML) is a visual representation of the capital asset pricing model (CAPM).
SML is a theoretical representation of the expected returns of assets based on systematic or non-diversifiable risk.
The concept of beta is central to the CAPM and the SML. The beta of a security is a measure of its systematic risk, which cannot be eliminated by diversification.
A beta value of one is considered the overall market average.
A beta value that’s greater than one represents a risk level greater than the market average, and a beta value of less than one represents a risk level that is less than the market average.
What is CML / Capital Market Line?
The capital market line (CML) represents portfolios that optimally combine risk and return.
It is a theoretical concept that represents all the portfolios that optimally combine the risk-free rate of return and the market portfolio of risky assets.
The Capital Market Line is a graphical representation of all the portfolios that optimally combine risk and return. CML is a theoretical concept that gives optimal combinations of a risk-free asset and the market portfolio. The CML is superior to Efficient Frontier because it combines risky assets with risk-free assets.
Key Differences between CML and SML
One of the differences between CML and SML, is how the risk factors are measured. While standard deviation is the measure of risk for CML, Beta coefficient determines the risk factors of the SML.
The CML measures the risk through standard deviation, or through a total risk factor. On the other hand, the SML measures the risk through beta, which helps to find the security’s risk contribution for the portfolio.
While the Capital Market Line graphs define efficient portfolios, the Security Market Line graphs define both efficient and non-efficient portfolios.
While calculating the returns, the expected return of the portfolio for CML is shown along the Y- axis. On the contrary, for SML, the return of the securities is shown along the Y-axis. The standard deviation of the portfolio is shown along the X-axis for CML, whereas, the Beta of security is shown along the X-axis for SML.
Where the market portfolio and risk free assets are determined by the CML, all security factors are determined by the SML.
Unlike the Capital Market Line, the Security Market Line shows the expected returns of individual assets. The CML determines the risk or return for efficient portfolios, and the SML demonstrates the risk or return for individual stocks.
CML vs SML Summary
1. The CML is a line that is used to show the rates of return, which depends on risk-free rates of return and levels of risk for a specific portfolio. SML, which is also called a Characteristic Line, is a graphical representation of the market’s risk and return at a given time.
2. While standard deviation is the measure of risk in CML, Beta coefficient determines the risk factors of the SML.
3. While the Capital Market Line graphs define efficient portfolios, the Security Market Line graphs define both efficient and non-efficient portfolios.
4. The Capital Market Line is considered to be superior when measuring the risk factors.
5. Where the market portfolio and risk-free assets are determined by the CML, all security factors are determined by the SML.
