Portfolio Management

It is the efficient frontier of all portfolios when a risk-free asset is combined with the market portfolio; expected return is a linear function of total risk (standard deviation).

E(Rp) = Rf + [(E(Rm) − Rf) / σm] × σp, where the bracketed term is the market price of risk (slope) and σp is the portfolio's total risk.

The SML graphs expected return against systematic risk (beta) and applies to ALL securities and portfolios, efficient or not, whereas the CML uses total risk and applies only to efficient portfolios.

E(Ri) = Rf + βi × [E(Rm) − Rf], where βi is the asset's systematic risk and [E(Rm)−Rf] is the market (equity) risk premium.

βi = Cov(Ri, Rm) / Var(Rm) = ρi,m × (σi / σm). It measures the sensitivity of the asset's returns to market returns.

Systematic (market) risk is non-diversifiable and affects all assets; unsystematic (firm-specific) risk can be eliminated through diversification. Only systematic risk is priced (rewarded) under the CAPM.