The Capital Market Line - The Efficient Frontier Step by Step

Adding a risk-free asset creates a straight risk-return line.

highlighted = computed this step

Add the risk-free asset

Now add a stated risk-free return of 4%. Combining that asset with any risky portfolio creates a straight risk-return line.

r_f=4\%

Capital market line

The capital market line starts at the risk-free return and passes through the tangency portfolio. Its rounded slope is 1803/5000.

r=r_f+\text{slope}\cdot\sigma,\quad \text{slope}\approx 1803/5000

Risk-free assumption

The risk-free asset and the capital market line are model assumptions. Real borrowing and lending rates can differ, and inputs are estimated with uncertainty. This is descriptive, not investment advice.

\text{risk-free rate is a stated input}