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Security Market Line (SML):
When the expected rate of return as per CAPM is presented graphically it will be a straight line sloping upward.
Lambda (λ):
Lambda indicates a reward-to-risk ratio where the numerator indicates reward in the form of market risk premium (Rm – Rf). The denominator indicates market risk indicated by standard deviation of the market (σm).
Capital Market Line (CML):
When the expected rate of return is related to absolute risk of the stock, i.e. with the standard deviation, and presented graphically it will be a straight line sloping upward.
Note:
On comparing CML with SML, it is observed that:
CML is based on Standard Deviation (σ), whereas SML is based on Beta (β).
CML considers absolute risk of Stock and Market (based on Standard Deviations), whereas SML considers relative risk of Stock with that of Market.
In CML, correlation between the security and the market is not considered, whereas SML considers correlation between the security and the market. (SML is based on CAPM).
If the correlation between security and market is perfectly positive, (i.e. Corxm = 1.00), the conclusions as per CML and SML will be the same.
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