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On an economics graph, the security market line shows market beta versus market return.

Beta is a number that describes a stock’s volatility – or risk -- relative to the market. If a particular stock’s value rises or falls at the same pace as the market as a whole, then it has a beta of 1. In other words, it has average risk.

If a stock’s price changes more than the market’s average price, it is more volatile, —indicated by a beta greater than 1. Stocks with less price variation than the rest of the market are less risky—shown by a beta lower than 1. Typically, stocks with market beta higher than 1 offer greater returns than those with market beta less than 1.

A security market line plots the average return for stocks that have a given value of beta, helping an investor determine whether an asset being considered for a portfolio offers a reasonable expected return for risk. Let’s say that General Flowers has a beta of 1, but pays a yield of 5%, which is higher than average. It will plot above the security market line. This means it is undervalued relative to its amount of risk.

Similarly, if National Chairs Co. has a beta of 1, but offers a yield of 3%, which is below average, it is likely overvalued, because it pays less than average for its amount of risk.

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