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PREPARED BYGURJIT KAURROLL NO:-01

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Security market line(SML) is graphicalrepresentation of Capital asset pricingmodel(CAPM).

It displays the expected rate of return of anindividual security as a function of systematic, non-diversifiable risk(beta).

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  CAPM = SML (GRAPH)

SML = E (Ri) = Rf + B[E(Rm) – Rf]

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SMLUNDERVALUED

OVERVALUED

STOCK

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Useful to determine asset consider forportfolio offers reasonable expected returnfor risk.

Individual security is plotted on graph.

Above SML, it is undervalued becauseinvestor can expect a greater return forinherent risk.

Below SML, it is overvalued because investorwould be accepting less return for amountrisk return.

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Assuming if risk free rate is 5%, and if overallstock will produce a rate of return 12.5% nextyear. XYZ company has a beta of 1.7%.

security

•

Risk free•Overall stock

market

•XYZ co.

beta

•

0.0•1.0

•1.7

Rate of return

•

5%•12.5%

•17.5%

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E(Ri) = Rf + Bi[E(Rm) – Rf]

Rf : RISK FREE RATE = 5%

B : BETA = 1.7%

Rm : MARKET RATE OF RETURN= 12.5%

SOLVING WITH FORMULA, WE GET=5 + 1.7[12.5 – 5]

=5 + 1.7[7.5]

=5 +12.5

=17.5%

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RATE OF RETURNSML

20

15

10

05 RISKFREE RATEBETA

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THANK YOU