Question

What’s Security Market Line (SML)? Draw the SML for an individual stock and interpret its intercept and slope.?

Answer 1

Security market line is the graphical representation of capital asset pricing model, which plots the expected return of the marketable securities against the systemic risk(market risk represented in form of beta) at a given point in time.

This SML is used by the investor to decide whether a security is over priced or underpriced. If the security is plotted below the SML, then it is over priced because the return of the security is less but the risk is higher for the risk taken. If the security is plotted above the security market line, then the security is undervalued, because the security gives higher return for the risk taken.