Capital Market Line

“Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk”  1964 William Sharpe

Capital Market Line is a special type of Capital Allocation Line, the risky portfolio is the market portfolio. Capital Allocation Line is a combination of risk-free asset with optimal risky portfolios. Risk-free asset has zero variance and zero correlation with risky assets. This factor is important when you combine a risky asset with a risk-free asset, the standard deviation of the portfolio is linearly proportional to the risky asset. 

This lesson derives the standard deviation of a portfolio consisting of a risky and risk-free asset. 

The Capital Market Line Assumptions are as follows.

All investors are risk-averse and are single period expected utility of terminal wealth maximisers

All investors have identical decision horizons and homogeneous expectations regarding investment opportunities

All investors are able to choose among portfolios solely based on expected returns and variance of returns

All transactions costs and taxes are zero

All assets are infinitely divisible

Video : Understanding The Capital Market Line | The middle Road 

The capital market theory is the underlying theory of the Capital Asset Pricing Model (CAPM) developed by William Sharpe (1964), Litner (1965), Mossin (1966), and Jack Treynor. CAPM led to an understanding of how risk impacts various assets, what type of risks can be diversified and how risk impacts return. For example, when a risky asset is combined with a risk-free asset. Risk-free asset developed Portfolio Theory into Capital Market Theory.