Capital Allocation Line Calculator

Capital Allocation Line Formula:

\[ Expected\ Return\ on\ Portfolio = ((Expected\ Return\ on\ Treasury\ Bill \times Weight\ of\ Treasury\ Bill) + (Expected\ Return\ of\ Stock \times Weight\ of\ Stock)) \times 100 \]

Expected Return on Treasury Bill:

Weight of Treasury Bill:

(0-1)

Expected Return of Stock:

Weight of Stock:

(0-1)

Expected Return on Portfolio:

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1. What is the Capital Allocation Line?

The Capital Allocation Line (CAL) represents the risk-return trade-off of a portfolio that combines a risk-free asset (such as Treasury bills) and a risky asset (such as stocks). It shows all possible combinations of risk and return available from different allocations between these two assets.

2. How Does the Calculator Work?

The calculator uses the Expected Return on Portfolio formula:

\[ Expected\ Return\ on\ Portfolio = ((Expected\ Return\ on\ Treasury\ Bill \times Weight\ of\ Treasury\ Bill) + (Expected\ Return\ of\ Stock \times Weight\ of\ Stock)) \times 100 \]

Where:

Expected Return on Treasury Bill — Anticipated return from T-bill investment (%)
Weight of Treasury Bill — Proportion of portfolio in T-bills (0-1)
Expected Return of Stock — Anticipated return from stock investment (%)
Weight of Stock — Proportion of portfolio in stocks (0-1)

Explanation: The formula calculates the weighted average return of a portfolio combining risk-free and risky assets.

3. Importance of Portfolio Return Calculation

Details: Calculating expected portfolio returns is crucial for investment planning, risk management, and optimizing asset allocation to achieve financial goals while managing risk exposure.

4. Using the Calculator

Tips: Enter expected returns as percentages (e.g., 5 for 5%), weights as decimals between 0-1 (e.g., 0.3 for 30%). Ensure weights sum to 1 for a complete portfolio allocation.

5. Frequently Asked Questions (FAQ)

Q1: What is the risk-free rate typically used in CAL?
A: Treasury bill rates are commonly used as the risk-free rate since they are considered free of default risk.

Q2: How does the CAL help in portfolio construction?
A: The CAL helps investors find the optimal mix of risk-free and risky assets that maximizes return for a given level of risk.

Q3: What assumptions underlie the Capital Allocation Line?
A: The CAL assumes investors can borrow and lend at the risk-free rate, and that risky assets have normally distributed returns.

Q4: How is risk measured in the CAL framework?
A: Risk is typically measured by the standard deviation of portfolio returns, representing the volatility of returns.

Q5: Can the CAL be used for multiple risky assets?
A: The basic CAL considers one risky asset, but the concept can be extended to multiple risky assets through the efficient frontier.