Overview

The capital allocation line (CAL) is a line chart which graphically shows the risk-and-reward profile of risky assets and is usually drawn to determine the optimal portfolio. There are multiple steps to constructing the CAL:

  1. Calculate the portfolio's expected return and variance
  2. Graph the efficient frontier using standard deviation as the x-axis and expected return as the y-axis
  3. Graph the capital allocation line (CAL) with the Sharpe ratio as its slope 
  4. Identify the optimal risky asset portfolio which is the point where the CAL is tangent to the efficient frontier
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