The SML is a general CML (informal FRM tip series)

A forum member asked me this great question; "If the CML plots well-diversified portfolios, and well-diversified portfolios have no idiosyncratic risk, then isn't the CML also a plot of systematic risk (aka, beta)? Put another way, doesn't the CML already map to the SML?" My response is here forum.bionicturtle.com/thread...
This mathematically explains why my favorite summary distinction of the difference between the CML and SML is this: the CML plots only (the most) efficient portfolios, but the SML plots all portfolios (including inefficient portfolios). I hope that's interesting!
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[@TheGiftRF]

You were a great resource while I was in university, thank you! I had forgot about this channel, will definitely come back to brush up on some concepts 👍

[@bionicturtle]

Thank you for the support, please do come back!

[@aboyinfinland9230]

Sir, thank you is not even enough. I am hoping to land a job in risk and first pay check I'll buy your full frm package including those immaculate spreadsheet descriptions. The practicality is pure genius and to have been doing it since 08' on CZcams is quite impressive. Thank you so so much!

[@exo7816]

I've got an exam coming up tomorrow on exactly this topic. Thanks for the great explanation! Definitely helped more than the professor's explanation

[@neommusi7964]

Hi I’m final year student in Varsity and completing financial Management. I was hoping know to where can I get these spreadsheets or excels sheets for practical practice

[@bionicturtle]

If you watch to the end, you will see the mapping. Where ER(M) is the market's excess return, and because *β(p, M) = σ(M)*σ(P)*ρ(p,M)/σ^2(M)* , we can express the *SML->CAPM* as given by *E(r) = Rf + [ER(M)*/σ(M)] * σ(p)*ρ(p,M)* . Portfolios on the most-efficient (straight line) CML are _special cases_ of this SML where ρ(p,M) = 1.0; i.e., truly well-diversified portfolios. Any _single point_ (portfolio) on the SML maps to _multiple points_ (portfolios) on the left-hand μ-versus-σ space. Equivalently, _multiple points_ on the same horizontal line in the CML space map to the same _single point_ on the SML line, but among them only the CML point has a perfect ρ(p,M) = 1.0 which is the meaning, in this context, of well-diversified. Hence the meaning of my title: the SML includes the most-efficient CML (as a specific case) but generalizes to inefficient portfolios as well.
We can quantify the implied *correlation-volatility tradeoff* , in my example (I am rounding now), at 150% leverage: on the CML where ρ(p,M) = 1.0 per CML the E(r) = Rf + [ER(M)*/σ(M)] * σ(p) = 6.0% + (6.59%/11.68%) * 17.51% = 15.89%. The less efficient portfolio has a ρ'(p',M) = 0.89 with implied volatility of 17.51%/0.89 = 19.68%. That's the tradeoff: lower correlation --> higher volatility. It has the same beta of 1.50 and therefore the same E(r) under the SML. Further, we can reverse out its implied specific risk which is given by SQRT(19.68%^2 - 1.50^2 * 11.68%^2) = 8.98% (rounds to 9.0% in my video). Cool, right?

[@hernanalzate1582]

Thank you so much for this valuable video, I wonder if it is possible to get the spreadsheet model.

[@user-td7lm3bd2f]

Thank you! Is there provided excel example?

[@pushkarjain2494]

How come truly diversified portfolio have a correlation of 1?
Isn't the point of diversification to reduce the correlation/

[@marcosjaime7249]

Excellent sus videos. Thank you.

[@marksmith4892]

How is it possible for a maximally diversified portfolio, i.e., with correlation = 1, to not actually BE the market portfolio?? What would be an example of this?

[@sali1806]

Hi, your videos are very lively and interesting, and I am looking forward to working with you. How can I contact you?