Capital Allocation Line | Modern Portfolio Theory |  | CAL | Essentials of Investments | CFA Exam
Channel: Farhat Lectures. The # 1 CPA & Accounting Courses
Date: 2020-08-03

Capital allocation line (CAL) is a graph created by investors to measure the risk of risky and risk-free assets. The Capital Allocation Line (CAL) is a line that graphically depicts the risk-and-reward profile of assets, and can be used to find the optimal portfolio.

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What Is the Capital Allocation Line (CAL)?
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. 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.


Understanding the Capital Allocation Line (CAL)
The capital allocation line aids investors in choosing how much to invest in a risk-free asset and one or more risky assets. Asset allocation is the allotment of funds across different types of assets with varying expected risk and return levels, whereas capital allocation is the allotment of funds between risk-free assets, such as certain Treasury securities, and risky assets, such as equities.


Constructing Portfolios With the CAL
An easy way to adjust the risk level of a portfolio is to adjust the amount invested in the risk-free asset. The entire set of investment opportunities includes every single combination of risk-free and risky assets. These combinations are plotted on a graph where the y-axis is the expected return and the x-axis is the risk of the asset as measured by the standard deviation.