.
( 1 ) .
The CML shows the relationship between the expected rate of return and risk of return( measured by standard deviation ). Individual risky securities always plot below the CML since the single risky security when held by itself is an inefficient portfolio. However, CML does not give the expected return to inefficient asset. This can be solved by capital asset pricing model .(1.) & (2.) (4. ).
Since the market portfolio M is efficient , the expected return of any asset i satisfies:.
( 2 ).
where : ( 3 ).
Therefore, the equilibrium relationship between risk and return can be written as :.
( 4 ).
E( R ) E(R).
E(Rm) M E(Rm) M.
R R.
1 .
Figure 2.a Figure 2.b.
We gave a graphic treatment to CAPM formula (4) , the figure 2 shows a linear relationship which termed the security market line ( SML ). Both figure 2.a and 2.b show the linear variation of E( R ). Figure 2.a expresses it in covariance form ,M corresponds to the point ; 2.b shows it in beta form and M corresponds to the point =1. Therefore, efficient set plot on the both CML and SML , but inefficient set plot on the SML below the CML. (1) (4).
APM:.
The arbitrage pricing model is an equilibrium model of asset pricing . It states that the expected return on a security is a linear function of the security's sensitivity to various common factors. This model does not require the assumption that investor evaluate the portfolio on the basis of means-variance. .
Assumption:.
1. Investors will seize the opportunity, which can increase the return of their portfolio without increase the risk.
2. Security returns are related to an unknown number of factors.