Security market line

Security market line (SML) is the representation of the capital asset pricing model.

It displays the expected rate of return of an individual security as a function of systematic, non-diversifiable risk.

The slope of the SML is equal to the market risk premium and reflects the risk return tradeoff at a given time: where: When used in portfolio management, the SML represents the investment's opportunity cost (investing in a combination of the market portfolio and the risk-free asset).

A rational investor will accept these assets even though they yield sub-risk-free returns, because they will provide "recession insurance" as part of a well-diversified portfolio.

A stock picking rule of thumb for assets with positive beta is to buy if the Treynor ratio will be above the SML and sell if it will be below (see figure above).