Capital allocation line (CAL)

What it means

The set of risk–return combinations available by mixing a risky portfolio with the risk-free asset.

The exam angle

Its slope is the Sharpe ratio of the risky portfolio, so the steepest CAL identifies the optimal risky portfolio for everyone.

Where it appears in the syllabus

• Portfolio ConstructionCFA Level I · exam weight 8–12% · Risk and return, the CAPM, IPS construction, behavioural biases.

Related terms

• AlphaReturn in excess of what the asset’s risk exposures would predict.
• Behavioural biasA systematic departure from rational decision-making, either cognitive — an error of reasoning that education can…
• BetaThe sensitivity of an asset’s return to the market’s return — its share of systematic risk.
• Capital asset pricing modelA model stating that an asset’s expected return equals the risk-free rate plus beta times the equity risk premium.
• Capital market lineThe capital allocation line that runs from the risk-free asset to the market portfolio, the steepest available.
• CorrelationCovariance divided by the product of the two standard deviations, giving a unit-free number between −1 and +1.