Security Market Line

The Security Market Line, or SML is a graphical representation used to depict the relationship between the expected return of an investment and its risk, as measured by beta.

The Security Market Line describes the pricing of securities in the market based on their risk levels relative to an overall market benchmark.

The SML is plotted on a graph where the y-axis represents the expected return of a security, the x-axis represents its beta, and the market risk premium, is the additional return an investor expects for taking on higher risk.

The plotting of the Security Market Line determines whether an investment product would offer a favorable expected return compared to its level of risk.

Consider Salt Corp with a beta of zero point five. If the risk-free rate is three percent and the market risk premium is five percent, the corporation will decide to invest based on its expected return on such an investment.

Investors use the Security Market Line to evaluate an investment product they plan to include in their portfolio based on systematic risk. It helps in guiding them in making informed investment decisions.