Capital allocation line (CAL) is a graph created by investors to measure the risk of risky and risk-free assets. The graph displays to the investors on the return they can make by taking on a certain level of risk. It is also known as a "reward-to-variability ratio".

Formula

It can be proven that it is a straight line and that it has the following equation:


In this formula P is the risky portfolio, F is the riskless portfolio, and C is a combination of portfolios P and F.

The slope of the capital allocation line is equal to the incremental return of the portfolio to the incremental increase of risk. Hence, the slope of the capital allocation line is called the reward-to-variability ratio because the expected return

Expected return

The expected return is the weighted-average outcome in gambling, probability theory, economics or finance.It isthe average of a probability distribution of possible returns, calculated by using the following formula:...

 increases continually with the increase of risk as measured by the standard deviation

Standard deviation

Standard deviation is a widely used measure of variability or diversity used in statistics and probability theory. It shows how much variation or "dispersion" there is from the average...

.

See also

• Capital market line
• Security market line
  Security market line
  Security market line is the graphical representation of the Capital asset pricing model. It displays the expected rate of return of an individual security as a function of systematic, non-diversifiable risk .-See also:...
  
  
• Security characteristic line
  Security characteristic line
  Security characteristic line is a regression line, plotting performance of a particular security or portfolio against that of the market portfolio at every point in time. The SCL is plotted on a graph where the Y-axis is the excess return on a security over the risk-free return and the X-axis is...
  
  
• Market portfolio
  Market portfolio
  Market portfolio is a portfolio consisting of a weighted sum of every asset in the market, with weights in the proportions that they exist in the market, with the necessary assumption that these assets are infinitely divisible....
  
  
• Sharpe ratio
  Sharpe ratio
  The Sharpe ratio or Sharpe index or Sharpe measure or reward-to-variability ratio is a measure of the excess return per unit of deviation in an investment asset or a trading strategy, typically referred to as risk , named after William Forsyth Sharpe...
  
  , which equals the slope of the Capital Allocation Line