Security Market Line (SML) is the graphical representation of the Capital Asset Pricing Model.It can be considered as a very useful tool for investor to find out that whether the expected return on the securities is better than the risk which he is taking.Is the security under or overvalued. It displays the expected rate of return for an overall market as a function of systematic, non-diversifiable risk (its beta).
Now each of the 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.
Formula: Ri=Rf+[Rm-Rf]*B Ri= Risk of the investment Rf= Risk free rate Rm= Market risk B= Beta
How to calculate it in excel