CAPM

Independent of the investors’ risk preferences, there exists only one efficient pure stock portfolio, the so-called tangency portfolio, that a rationale investor combines with the riskfree asset.

The CML graphs the risk premiums of efficient portfolios (i.e., portfolios composed of the market and the risk-free asset)as a function of portfolio standard deviation.

This is appropriate because standard deviation is a valid measure of risk for efficiently diversified portfolios.

The SML graphs individual asset risk premiums as a function of beta (asset risk).

The relevant measure of risk for individual assets is not the asset’s standard deviation or variance; it is, instead, the contribution of the asset to the portfolio variance, which we measure by the asset’s beta. The SML is valid for both efficient portfolios and individual assets.

The market portfolio is a value-weighted portfolio of all securities traded in the market.

According to the CAPM, all investors hold a combination of the market portfolio and the risk free asset