• Invest
    Investment Suite
    Stocks
    Mutual Funds
    Future and Options
    IPO
    Exchange Traded Funds
    Commodity
    Stockcase (Stock Baskets)
    Currency
    Non Convertible Debentures
    Sovereign Gold Bond
    Exclusive
    NRI Account
    Private Client Group
    Features
    SipIt
    MTF
    Investment Suite
    Exclusive
    Features
  • Platform
    Product Suite
    Kotak Neo App & Web
    Nest Trading Terminal
    NEO Trade APIs
    Features and Tools
    MTF
    Securities Accepted as Collateral
    Margin Requirements
    Equity Screeners
    Payoff Analyzer
    Calculators
    SIP Calculator
    Lumpsum Calculator
    Brokerage Calculator
    Margin Calculator
    MTF Calculator
    SWP Calculator
    CAGR Calculator
    Simple Interest Calculator
    ELSS Calculator
    Step up SIP Calculator
    All Calculators
    Product Suite
    Features and Tools
    Calculators
  • Pricing
  • Research
    Research Calls
    Long Term calls
    Short Term calls
    Intraday calls
    Derivatives calls
    Pick of the week
    Top Monthly Picks
    Research Reports
    Fundamental Research Report
    Technical Research Report
    Derivative Research Report
    Research Calls
    Research Reports
  • Market
    Stocks
    Market Movers
    Large Cap
    Mid Cap
    Small Cap
    Indices
    Nifty 50
    Bank Nifty
    FinNifty
    Nifty Midcap India
    VIX
    All Indian Indices
    Mutual Funds
    SBI Mutual Funds
    HDFC Mutual Funds
    Axis Mutual Funds
    ICICI Prudential Mutual Funds
    Nippon India Mutual Funds
    All AMC's
    IPO
    Upcoming IPO
    Current IPO
    Closed IPO
    Recently Listed IPO
    Stocks
    Indices
    Mutual Funds
    IPO
  • Learn
    Resource
    Market Ready
    Kotak Insights
    Infographic
    Podcast
    Webinars
    Youtube Channel
    Quarterly Results
    Investing Guide
    Demat Account
    Trading Account
    Share Market
    Intraday Trading
    IPO
    Mutual Funds
    Commodities
    Currency
    Futures & Options
    Derivatives
    Margin Trading
    Events
    Budget 2024
    Muhurat Trading
    Share Market Holiday
    Market Outlook 2025
    Resource
    Investing Guide
    Events
  • Partner
    Business Associates
    Fund Expert
    Kotak Connect Plus
    Startup connect
  • Support
    FAQs
    Circulars
    Bulletins
    Contact Us
    Forms Download
    Get your Statement
​

Difference between SML and CML

  •  5 min read
  • 0•
  • 13 Nov 2024
Difference between SML and CML

In the financial industry, many analytical tools are available to help investors manage the challenging landscape of shares and market patterns. These resources are valuable guides for investors to increase their profit potential, reduce risk, and widen their investing horizons. The Security Market Line (SML) and the Capital Market Line (CML) are useful tools for managing risk in investment portfolios. Read this article to get a clear understanding of SML and CML and to understand the major differences between SML and CML.

Key Takeaways:

  • CML focuses on building effective portfolios by mixing risky assets with risk-free assets, while SML evaluates individual securities based on systematic risk.

  • CML helps create portfolios that balance risk and return, and SML assists in determining the value of individual assets.

  • By understanding the difference between SML and CML, investors may optimise returns while successfully controlling risk by making well-informed decisions about portfolio management and asset allocation.

Let's quickly understand what SML and CML mean before getting into the differences:

Capital Market Line (CML) The Capital Market Line (CML) represents portfolios that balance return and risk best. It is a theoretical concept that illustrates all possible combinations of the market portfolio of risky assets and the risk-free rate of return. According to the Capital Asset Pricing Model (CAPM), which assumes that investors aim to maximize profit for a given level of risk, all investors will take an equilibrium position on the CML by either borrowing or lending at the risk-free rate.

Security Market Line (SML) Like the CML, the security market line (SML) is a graphical depiction of an asset's predicted returns and risk. The SML doesn't focus on whole portfolios as the CML does; instead, it just considers individual assets. It illustrates the correlation between the expected return of an asset and its systematic risk, as determined by its beta. The beta measures an asset's systematic risk and reflects how sensitive it is to changes in the market.

CML visually represents the conflict between risk and reward that you may face while building a portfolio of various assets. The advantages of diversity and how it may increase profits without taking on undue risk are highlighted by the capital market line. The CML slope calculates the portfolio’s incremental return per unit of risk, sometimes referred to as the Sharpe ratio. Hence, it acts as a roadmap for creating portfolios that strike a compromise between responsible risk management and the objective of delivering higher returns.

Just like CML, the security market line is a graphical representation of the risk and expected returns of an asset. But there's a difference, the SML focuses solely on individual assets rather than complete portfolios, unlike CML. It illustrates the correlation between the expected return of an asset and its systematic risk, as determined by its beta. The beta measures an asset's systematic risk and reflects how sensitive it is to changes in the market.

Here is a table of differences between SML and CML:

Basics SML CML
Purpose
It is based on systematic risk and determines the predicted returns of individual securities.
By balancing high-risk and low-risk investments it builds the best possible portfolios.
Functioning
Efficiency is low
High efficiency
Parameters Used
Systematic Risk
Diversification with risk-free rate.
Application
Valuing and selecting assets
Optimisation of Portfolio
Components
SML includes, both, the risk-free rate and one risky asset in the market portfolio.
CML combines a risk-free asset with a risky asset.
Graphical Representation
It is shown as a straight line with a beta of 1.0 that crosses the y-axis at a risk-free rate to represent the projected return of the market portfolio.
CML is shown as a line that touches the efficient frontier tangentially and originates from the risk-free rate.

You may choose between the Security Market Line (SML) and the Capital Market Line (CML) based on your investing goals and preferences. The SML is a great tool for research if your main focus is on evaluating individual assets and their valuation concerning risk. On the other hand, the CML provides a thorough framework for building a diversified portfolio that maximizes the trade-off between risk and return.

Essentially, the responsibilities that the SML and the CML play are different yet complementary. While the CML makes it easier to create well-balanced portfolios, the SML helps with asset selection and valuation. Your choice between the two should be based on your risk tolerance and investing objectives as an investor.

SML and CML are both important tools in financial analysis and investment management, although they have different uses and functions. CML is concerned with creating ideal portfolios that include risky and risk-free assets to balance risk and return, SML is focused on analysing individual securities according to their systematic risk. By using a share market app, investors may improve their capacity to track their investments, obtain real-time market data, and make well-informed judgments.

FAQs on SML vs CML

SML is depicted as a straight line intersecting the y-axis at a risk-free rate whereas CML is represented as a line originating from the risk-free rate and touching the efficient frontier.

The purpose of SML is to analyse securities and their valuation based on systematic risk and the purpose of CML is to help to construct well-balanced portfolios that optimise the risk-return tradeoff.

Both are graphical representations of risk-return combinations, the CML and SML are comparable models of the risk-return tradeoff.

Yes, SML and CML are complementing tools for investment research and portfolio management even if they have distinct uses.

The efficiency of SML is low whereas the efficiency of CML is high.

Did you enjoy this article?

0 people liked this article.

What could we have done to make this article better?

Enjoy Free Demat Account Opening
+91 -

personImage
Enjoy Free Demat Account Opening
+91 -