What is the 'Capital Market Line  CML'
The capital market line (CML), in the capital asset pricing model (CAPM), depicts the tradeoff between risk and return for efficient portfolios. It is a theoretical concept that represents all the portfolios that optimally combine the riskfree rate of return and the market portfolio of risky assets. Under CAPM, all investors will choose a position on the capital market line, in equilibrium, by borrowing or lending at the riskfree rate, since this maximizes return for a given level of risk.
BREAKING DOWN 'Capital Market Line  CML'
The capital market line (CML), in the CAPM, is the line that connects the riskfree rate of return with the tangency point on the efficient frontier of optimal portfolios that offer the highest expected return for a defined level of risk, or the lowest risk for a given level of expected return. The portfolios which have the best tradeoff between expected returns and variance (risk) lie on this line. The tangency point is the optimal portfolio of risky assets, known as the market portfolio. Under the assumptions of meanvariance analysis – that investors seek to maximize their expected return for a given amount of variance risk, and that there is a riskfree rate of return – all investors will select portfolios which lie on the CML.
According to Tobin's separation theorem, finding the market portfolio and the best combination of that market portfolio and the riskfree asset are separate problems. Individual investors will either hold just the riskfree asset, or some combination of the riskfree asset and the market portfolio, depending on their riskaversion. As an investor moves up the CML, the overall portfolio risk and return increases. Risk averse investors will select portfolios close to the riskfree asset, preferring low variance to higher returns. Less risk averse investors will prefer portfolios higher up on the CML, with a higher expected return, but more variance. By borrowing funds at the riskfree rate, they can also invest more than 100% of their investable funds in the risky market portfolio, increasing both the expected return and the risk beyond that offered by the market portfolio.
The Capital Market Line Equation
The return on portfolio p, where R_{T} and σ_{T} are tangency portfolio T’s return and standard deviation, is the riskfree rate of return plus the tradeoff between risk and return, (R_{T} r_{f})/σ_{T}  also known as the Sharpe ratio  multiplied by the standard deviation of portfolio p.
The Capital Market Line, the Capital Allocation Line and the Security Market Line
The CML is sometimes confused with the capital allocation line (CAL) and the security market line (SML). While the CAL is one of an infinite number of lines plotting the possible combinations of the risk free asset and a portfolio of risky assets  depending on investors' return expectations — the CML is the specific instance where the risky portfolio is the market portfolio. The CML is the CAL with the highest Sharpe ratio (slope). The Sharpe ratio is the average return earned in excess of the riskfree rate per unit of volatility or total risk. The greater the value of the Sharpe ratio, the more attractive the riskadjusted return.
The SML is derived from the CML. While the CML shows the rates of return for a specific portfolio, the SML represents the market’s risk and return at a given time, and shows the expected returns of individual assets. And while the measure of risk in the CML the standard deviation of returns (total risk), the risk measure in the SML is systematic risk, or beta. Securities that are fairly priced will plot on the CML and the SML. Securities that plot above the CML or the SML are generating returns that are too high for the given risk and are underpriced. Securities that plot below CML or the SML are generating returns that are too low for the given risk and are overpriced.
History of the Capital Market Line
Meanvariance analysis was pioneered by Harry Markowitz and James Tobin. The efficient frontier of optimal portfolios was identified by Markowitz in 1952, and James Tobin included the riskfree rate to modern portfolio theory in 1958. William Sharpe then developed the CAPM in the 1960s, and won a Nobel prize for his work in 1990, along with Markowitz and Merton Miller.

Efficient Frontier
Efficient frontier is a portfolio that offers the highest expected ... 
Capital Asset Pricing Model  CAPM
Capital Asset Pricing Model is a model that describes the relationship ... 
RiskFree Return
Riskfree return is the theoretical return attributed to an investment ... 
Security Market Line  SML
The security market line (SML) is a line drawn on a chart that ... 
Market Portfolio
A market portfolio is a theoretical, diversified group of investments, ... 
Frontier Markets
Frontier markets are less advanced capital markets in the developing ...

Investing
Want A HighYield Healthcare Stock? Look To Canada
CML HealthCare isn't flashy, but it's a reliable dividend payer. 
Financial Advisor
Measure Your Portfolio's Performance
Measuring the success of your investment solely on the portfolio return may leave you blindsided to risk. Learn how to evaluate your investment return. 
Investing
Explaining The Efficient Frontier
Most investment choices involve a tradeoff between risk and reward. The "Efficient Frontier" is a modern portfolio theory tool that shows investors the best possible return they can expect from ... 
Investing
Taking Shots at CAPM
Find out why many investors think the capital asset pricing model is full of holes. 
Investing
How Risk Free Is the RiskFree Rate of Return?
This rate is rarely questioned—unless the economy falls into disarray. 
Investing
Understanding Market Risk Premium
Market risk premium is equal to the expected return on an investment minus the riskfree rate. The riskfree rate is the minimum rate investors could expect to receive on an investment if it ... 
Tech
CAPM vs. Arbitrage Pricing Theory: How They Differ
Both project the expected rate of return given the level of risk assumed, but they consider different variables.

How is the Capital Asset Pricing Model (CAPM) represented in the Security Market ...
Learn about the capital asset pricing model and the security market line and how the model is used in the calculation and ... Read Answer >> 
How does market risk affect the cost of capital?
Find out how market risk directly affects the total cost of capital, including how to use the capital asset pricing model ... Read Answer >> 
How is the riskfree rate determined when calculating market risk premium?
Learn how the riskfree rate is used in the calculation of the market risk premium, and understand why Tbills provide the ... Read Answer >> 
Is there a positive correlation between risk and return?
Learn about the positive correlation between risk and the potential for return, and understand how risk is used to construct ... Read Answer >> 
What is the formula for calculating the capital asset pricing model (CAPM) in Excel?
Find out more about the capital asset pricing model (CAPM) and the formula for calculating it in Microsoft Excel. Read Answer >>