The picture below depicts a set of possible investment //''portfolios''//. The risk of a portfolio comprises systematic risk, also known as [[Undiversifiable Risk]], and unsystematic risk which is also known as [[Diversifiable Risk]], usually proxied by the standard deviation of the portfolio's return. Undiversifiable risk refers to the risk common to all securities which is the market risk.

* $\Large r_M$ is the ''average market risk''
* $\Large {\sigma}_M$ is the ''average variance on the market risk''
* $\Large r_F$ is the ''[[Risk free rate of return]]''
* The red dot in the picture marks the ''full market portfolio''
* The ''Efficient set'' (the blue line) represents the ''biggest return possible'' for each given risk profile

The CAPM assumes that the risk-return profile of a portfolio can be optimized - an optimal portfolio displays the lowest possible level of risk for its level of return.

<<image /static/files/MBI/Module%2013/CAPM.png width:800>>

By adding a risk free asset to a portfolio, one can reduce risk:
<<image /static/files/MBI/Module%2013/CAPM_riskfree.png width:800>>

By borrowing and increasing your portfolio you can increase return:

<<image /static/files/MBI/Module%2013/CAPM_borrowing.png width:800>>

By doing both 1) and 2) we get the Capital Market Line:

<<image /static/files/MBI/Module%2013/CAPM_capitalmarketline.png width:800>>

bag
finance_public
created
Fri, 06 Jan 2012 13:25:49 GMT
creator
dirkjan
modified
Fri, 06 Jan 2012 13:25:49 GMT
modifier
dirkjan
tags
M13
Term
creator
dirkjan