Security Market Line is a plot of level of systematic and non-diversifiable risk taken versus the expected return of the market at a given time for all the risky assets.

Mathematically,

R_{p} = R_{f} + β(R_{m} – R_{f})

Where,

R_{p} =Required Return

R_{f }= Risk free rate

β = Systematic Risk (Beta)

R_{m} =Market Return

R_{m} – R_{f} = Market Risk Premium = This is the amount by which expected rate of return exceeds the risk-free rate of return.

β(R_{m} – R_{f}) = Risk Premium

Any stock (x, y, z) that has expected rates of return with a plot which is above the SML is **under-priced** as here the expectation is to receive a return on the stock which is above its required rate of return for a given systematic risk(β). Any stock (P, Q, R) which has expected rates of return with a plot which is below the SML is **over-priced** as here the expected rate of return is below its required rate of return for a given beta. The reasons for x, y, z are under-priced as compared to P, Q, R is that although x, y, z have same risk as that of P, Q, R respectively, x, y, z gives higher returns.

__Example:__

Suppose beta of a stock is 1.3, risk free rate of return is 5% and expected return on the market is 12%. Find the expected return for the stock.

R_{p }= R_{f} + β (R_{m} – R_{f})

= 5% + 1.3 (12% -5%) = 14.1%

__Capital Market Line (CML) Vs Security Market Line (SML)__

- CML tells about the risk or return of portfolio whereas SML tells the risk or return of individual stocks
- CML graphs defines efficient portfolios whereas SML graph defines efficient as well as non-efficient portfolios.
- CML uses Standard deviation to measure risk and SML uses beta to measure risk.