Investments, tenth edition

A: The Efficient Frontier of Risky Assets with the Optimal CAL

B: The Efficient Frontier and the Capital Market Line

P

r

f

σ

E(r

P

)

σ

P

E(r)

CML

Efficient Frontier

M

r

f

σ

E(r

M

)

σ

M

 Figure 9.1 

Capital allocation line and the capital market line     

4

 We use the term “stock” for convenience; the market portfolio properly includes all assets in the economy. 

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Final PDF to printer

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  C H A P T E R  

9

  The Capital Asset Pricing Model  

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 Now suppose that the optimal portfolio of our investors does not include the stock of 

some company, such as Delta Airlines. When all investors avoid Delta stock, the demand 

is zero, and Delta’s price takes a free fall. As Delta stock gets progressively cheaper, it 

becomes ever more attractive and other stocks look relatively less attractive. Ultimately, 

Delta reaches a price where it is attractive enough to include in the optimal stock portfolio. 

 Such a price adjustment process guarantees that all stocks will be included in the opti-

mal portfolio. It shows that  all  assets have to be included in the market portfolio. The only 

issue is the price at which investors will be willing to include a stock in their optimal risky 

portfolio.