header bg

Question:

When comparing portfolios that plot on the security market line (SML) to those that plot on the capital market line (CML), a financial analyst would most accurately state that portfolios that lie on the SML:

A are not necessarily well diversified, while portfolios on the CML are well diversified.
Explaination

Although the risk measure on the capital market line diagram is total risk, all portfolios that lie on the CML are well diversified and have only systematic risk. This is because portfolios on the CML are all constructed from the risk-free asset and the (well-diversified) market portfolio. Any portfolio, including single securities, will plot along the SML in equilibrium. Their unsystematic risk can be significant, but it is not measured on the SML diagram because unsystematic risk is not related to expected return. Both the CML and the SML reflect relations that hold when prices are in equilibrium.