What is the 'Security Market Line  SML'
The security market line (SML) is a line that graphs the systematic, or market, risk versus return of the whole market at a certain time and shows all risky marketable securities.
Also referred to as the "characteristic line."
The SML essentially graphs the results from the capital asset pricing model (CAPM) formula. The xaxis represents the risk (beta), and the yaxis represents the expected return. The market risk premium is determined from the slope of the SML.
BREAKING DOWN 'Security Market Line  SML'
The security market line is a useful tool in determining whether an asset being considered for a portfolio offers a reasonable expected return for risk. Individual securities are plotted on the SML graph. If the security's risk versus expected return is plotted above the SML, it is undervalued because the investor can expect a greater return for the inherent risk. A security plotted below the SML is overvalued because the investor would be accepting less return for the amount of risk assumed.The SML demonstrates a linear relationship between anticipated asset returns as betas, as suggested by the capital asset pricing model (CAPM). A beta is a measure of the risk associated with a particular security as it relates to the market. A beta of one is considered to be market average, while a beta of 1.5 would represent a risk of one and a half times the market average. Betas are said to represent systematic risk which is considered undiversifiable.
The SML and Risk
The SML provides a way to compare the riskiness of a particular stock as compared to the overall market performance and is defined by the CAPM. The SML low point correlates to items considered zero risk, such as guaranteed bonds. The midpoint represents the current market performance average. The highest point denotes the highest risk.
The SML and Trade Decision Analysis
The SML provides a way for investors to determine if the amount of potential reward, based on anticipated returns, corresponds with the amount of risk involved with the particular security. In general, the higher the risk, the higher investors want the potential for returns to be, based on an assumed linear relationship between the two concepts.
When deciding between multiple securities with the same expected return, an investor may choose the one with the lowest risk necessary to achieve that return. If all risk is considered the equal, the choice would be based on which security provided the highest return.

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How do I interpret a Security Market Line (SML) graph?
Find out how to interpret stocks and portfolios through a security market line, or SML, graph as part of the Capital Asset ... Read Answer >> 
How is the Capital Asset Pricing Model (CAPM) represented in the Security Market ...
Learn about the capital asset pricing model and the security market line and how the model is used in the calculation and ... Read Answer >> 
What is the formula for calculating the capital asset pricing model (CAPM)?
Learn about the capital asset pricing model, or CAPM, and how this formula is used to determine the expected rate of return ... Read Answer >> 
How does beta measure a stock's market risk?
Learn how beta is used to measure risk versus the stock market, and understand how it is calculated and used in the capital ... Read Answer >> 
What kinds of securities are influenced most by systematic risk?
Learn what systematic risk is, how investors can measure it with beta and how securities with a beta greater than 1 are most ... Read Answer >> 
How does market risk affect the cost of capital?
Find out how market risk directly affects the total cost of capital, including how to use the capital asset pricing model ... Read Answer >>