The capital allocation line (CAL), also known as the capital market link (CML), is a line created on a graph of all possible combinations of risk-free and risky assets.

CAL starts at the point $r_f$ on the returns-axis, and touches the Efficient Frontier on a single point.

This point is the Tangency Portfolio

The graph displays the return investors might possibly earn by assuming a certain level of risk with their investment. The slope of the CAL is known as the reward-to-variability ratio.

• Visualize a portfolio that is made up of risky, yet efficient assets and the risk-free rate.
• Graphically speaking, such portfolios line up on a straight line which connects the risk-free

rate with the Efficient Frontier.

• The unique connecting line with the steepest slope is called 'Capital Allocation Line'?
• The corresponding efficient portfolio is called 'Tangency Portfolio'?
• The Tangency portfolio is the efficient portfolio with the highest Sharpe Ratio.
• The Sharpe Ratio is defined as the expected risk premium per unit of volatility.

SR, := Ep] = "

• if a Mean-Variance investor can buy a risk-free asset and borrow at the risk-free rate, all

optimal portfolios will be on the Capital Allocation Line.

• The exact location on the Capital Allocation line depends on the investor's degree of risk