Capital Market Line
The line showing the risk-return combinations available by mixing the risk-free asset with the optimal risky portfolio.
Formula
Expected Return = Risk-Free Rate + [(Market Return - Risk-Free Rate) / Market Standard Deviation] x Portfolio Standard Deviation
Unit
%
In depth
The line's implication is the separation theorem: every investor should hold the same optimal risky portfolio and adjust risk purely by how much of the risk-free asset they hold alongside it. In practice this is the argument for index funds plus bonds rather than for different equity portfolios at different risk levels. Its slope is the market's Sharpe ratio, which makes the line a benchmark against which any portfolio's risk-adjusted return can be judged. Points above the line are impossible in theory, and points below it represent inefficiency.
Worked example
A risk-free rate of 7%, market return 13% and market volatility 18% give a slope of (13 - 7) / 18 = 0.33. A portfolio with 9% volatility should therefore return 7 + 0.33 x 9 = 10%; earning 9% means it is below the line.
Illustrative figures, chosen so the arithmetic is easy to follow. Not a live price and not a valuation of any company.
Educational reference only
This entry explains what “Capital Market Line” means. It is not investment advice and not a recommendation to buy or sell any security. Any numbers above are illustrative, not live prices, and nothing here predicts price direction or rates a stock. Consider your own circumstances and consult a SEBI-registered investment adviser before acting.