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In Modern Portfolio Theory, the Security Market Line (SML) is the graphical representation of the Capital Asset Pricing Model. It displays the expected rate of return for an overall market as a function of systematic, non-diversifiable risk (its beta).
The Y-Intercept (beta=0) of the SML is equal to the risk-free interest rate. The slope of the SML is equal to the Market Risk Premium and reflects investors' degree of risk aversion at a given time.
When used in portfolio management, a single asset is plotted against the SML using its own beta and historical rate of return. If the plot of the asset falls above the SML it is considered to have a good rate of return relative to its risk (the asset is undervalued by the CAPM, and should be acquired), and vice versa if it falls below (the asset is overvalued, and should be sold).
See also
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