Capital Market Line

This lesson derives the standard deviation of a portfolio consisting of a risky and risk-free asset. This is part of the upcoming Capital Asset Pricing Model single-factor model and a build-up to the capital market line. The upcoming Capital Asset Pricing Model is not part of the subscription model.

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

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. 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. Watch the educational video on this subject, for a detailed overview refer to the upcoming course on CAPM.