FIN200 Assignment, Trimester 2 2018 Explain and graphically depict how Security Market Line (SML) is different from Capital Market Line (CML). Identify and discuss the importance of minimum variance...

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Running Header: Portfolio Theories
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Portfolio Theories
Portfolio Theories
Introduction:
Although the field of investment have its existence from the past but there was lack of the theory of formulation of the prices and the capital markets. So various portfolio theories and efficient market Hypothesis were developed for understanding the relationship between the risk and return, the behaving pattern of the capital market and how the price are established in the capital market. Risk and the return are two very important characteristics of each and every investment on which the decision of the investors is based upon. The investors want to reduce the variability of returns by the means of diversification of their investments. The same results in the creation of the portfolio by the investor. With the different securities available any number of the portfolios can be created. Some securities have more risk than other, some dominates other, and some are more efficient. The investor has to make decision regarding which securities he needs to include in this portfolio of the investments.
The various strategies established give the clear idea to the investors of the various market positions and the market situations prevailing at the time they are making the investments. These are necessary for the investors as they provide the investors about the various possibilities in the market where they can invest their money in order to earn maximum return with the minimum level of the investments.
Security Market Line and Capital market Line
Capital Market Line (CML)
Capital market line (CML) is the line which is used to show rate of returns that is dependent on the level of risk of the specified portfolio and risk free rate of return. The capital market line is derived by making the line from intercept point on efficient frontier to a point where expected return is equal to the risk free rate.
                                     Z
E (Rm) M    
        Expected rate of return                     A
                                 X
RF     y B
                            
                            Risk (Standard deviation)
                        Fig. 1 Capital Market Line (CML)
Here the line which is going from RF point to Z is the Capital Market Line and the curve line from A to B is the efficient frontier.
Security Market Line
The Security market line graphically presents the Capital Asset pricing model (CAPM). It shows the rate of return of security individually as function of the systematic and non diversible risk called beta.
                                     S
E (Rm)     
        Expected rate of return                    
        
RF         
                            
                            Beta
                    Fig. 2 Security Market Line (SML)
Here the line from RF to S is the Security Market Line. In this line there will be some of the points which will be above the line and some points will be below the line. The securities above the line will be underpriced and those below the line will be over priced. The underpriced securities will be bought by the investors and the overpriced securities will be sold. This price adjustment will continue till the securities will come at SML line.
The Security Market line (SML) differs from the Capital Market Line (CML) in different ways as follows:
1. The risk measurement as per capital market Line is done using the Standard deviation (Total risk factor) whereas the risk measurement as per Security market line (SML) is done using the beta as the beta helps in finding the risk of the security in the portfolio.
2. The graph of the Capital Market Line defines efficient portfolios whereas the graph of the Security Market defines both efficient as well as non-efficient portfolios.
3. When the returns are calculated, expected return in the Capital Market Line graph is shown along Y- axis. Whereas in case of Security Market Line, securities return are shown along Y-axis.
4. For the x- axis, under the case of Capital market line graph portfolios standard deviation is shown along X-axis whereas under the Security Market Line graph along the x axis Beta of the...