Security Market Line (SML)

Investors seeking risk exposure demand adequate compensation for the risk they take on. The Capital Asset Pricing Model is one tool widely used to calculate the premium over the risk-free rate of return investors should demand to hold a risk asset based on the asset’s Beta (volatility, or systematic, undiversifiable risk) relative to the market. The Security Market Line is an upwardly sloping line, a graphical theoretical representation of the CAPM plotting the expected rate of return for a given level of risk. A basic investing premise is that given two securities with identical returns, investors should always buy the security with less risk.