<p>The Capital Market Line (CML) is a fundamental concept in modern portfolio theory, illustrating the efficient frontier of a capital market. It represents the set of portfolios that offer the highest expected return for a given level of risk, or equivalently, the minimum risk for a given level of expected return.</p>

<h2>How It Works</h2>

<p>The CML is derived from the tangency point of the Markowitz mean-variance efficient frontier and the capital market portfolio. The capital market portfolio is a weighted combination of all assets in the market, with weights proportional to their market capitalization. The tangency point represents the portfolio that is most efficient in terms of risk-return trade-off, as it has the highest Sharpe ratio (risk-adjusted return).</p>

<p>The CML can be represented mathematically as:</p>

<table>
<tbody>
<tr>
<th>CML: E(r<sub>p</sub>) = r<sub>f</sub> + (E(r<sub>m</sub>) - r<sub>f</sub>) * β<sub>p</sub></th>
</tr>
</tbody>
</table>

<p>Where:</p>
<ul>
<li><strong>E(r<sub>p</sub>)></strong> is the expected return of the portfolio</li>
<li><strong>r<sub>f</sub>></strong> is the risk-free rate</li>
<li><strong>E(r<sub>m</sub>)></strong> is the expected return of the market portfolio</li>
<li><strong>β<sub>p</sub></strong> is the beta of the portfolio</li>
</ul>

<h2>Why It Matters for Traders</h2>

<p>The CML is a crucial concept for traders as it helps to:</p>
<ul>
<li>Identify the optimal risk-return trade-off</li>
<li>Compare the performance of their portfolio with the market portfolio</li>
<li>Understand the relationship between risk and return</li>
</ul>

<h2>Example</h2>

<p>Consider a trader using STB's MetaTrader 5 platform, who wants to create a portfolio with an expected return of 15%. If the risk-free rate is 2% and the expected market return is 10%, and the trader's portfolio has a beta of 1.2, then the expected return of the portfolio according to the CML would be:</p>

<p>E(r<sub>p</sub>) = 2% + (10% - 2%) * 1.2 = 14.4%</p>

<p>This shows that the trader's portfolio is slightly below the CML, indicating that it might be possible to improve the portfolio's risk-return profile.</p>

<h2>Key Takeaways</h2>

<ul>
<li>The Capital Market Line (CML) represents the efficient frontier of a capital market</li>
<li>It is derived from the tangency point of the Markowitz mean-variance efficient frontier and the capital market portfolio</li>
<li>The CML helps traders identify the optimal risk-return trade-off and compare their portfolio's performance with the market portfolio</li>
<li>It is represented mathematically as E(r<sub>p</sub>) = r<sub>f</sub> + (E(r<sub>m</sub>) - r<sub>f</sub>) * β<sub>p</sub>)</li>
</ul>