Question

Briefly discuss the concept of the Security Market Line (SML), and explain why all assets must plot

directly on it in a competitive market.

Answer 1

Security market line is a graphical representation of Capital Asset pricing model which reflect different levels of systematic risk for different level of expected return in the market of a certain security or different security.

Capital Asset pricing model as we all know is used to calculate the expected rate of return an investor wants to earn from the portfolio, and Beta is a reflection of the systematic risk which is also called as the market risk so this security market line is is reflection between interlinking of expected return and Beta of eportfolio.

All asset must fall directly on a security line in competitive market because all assets will have same risk to reward ratio and it will have same slope in a competitive market. These assets must plot directly on security market line as investor action will adjust price of assets to fall on that line .