Corporate Financial Management & Accounting Programs

Running head: CORPORATE FINANCIAL MANAGEMENT
Corporate financial management
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CORPORATE FINANCIAL MANAGEMENT1
Security market line and capital market line
Security market line (SML) represents CAPM. It displays return rate for individual
security as the function of systematic risk that is considered as non-diversifiable. It is in other
words, the line drawn on the chart that provides graphical representations of CAPM and reveals
various levels of market or systematic, risks of plotting number of marketable securities while
comparing expected return for overall market at the specified time point. It is also termed as
characteristic line. The SML is graphical for CAPM where x-axis of chart reveals risks in the
context of beta and the y-axis of chart reveals the expected return. Premium for market risk for
any underlying security is established by where the same is plotted on chart associated with SML
(Jylhä, 2018).
SML is used as a tool for evaluating the investment that is generated from CAPM which
is the model that states relationship for the securities and is dependent on assumptions that the
investors are required to be reimbursed for time value of money as well as associated risk level

CORPORATE FINANCIAL MANAGEMENT2
related to any investment that is termed as risk premium. Beta concept is central to CAPM and
SML. Beta of the security is approached for measuring the systematic risk that cannot be
disregarded through diversification. If the value of beta is greater than market average signifies
risk level of higher more than market average while the beta value lesser than 1 indicates risk
level below the market average (De Giorgi, Post & Yalçın, 2019). Formula for plotting SML is –
Required return = Risk free (Rf) rate for return + Beta (Market return – Rf rate for return)
SML is generally approached by the investors while analysing security for including the
same in investment portfolio in context of whether security provides favourable expected return
as compared to risk level. While security is plotted on chart of SML, if the same look like above
SML, it is accounted for as devalued as position on chart signifies that security proposes greater
return while compared to inherent risk. On the contrary, if security is plotted below SML, it is
accounted for as devalued in term of price as forecasted return is not able to overcome the
inherent risk (Han, Li & Li, 2019).
Frequently SML is used for comparing 2 comparable securities those offer imprecisely
same return for determining which one among the two securities is exposed to lower level of
inherent market risk as compared to forecasted return. SML can further be used for comparing
securities of the equal risk to analyse which offer among two has highest expected return. While
SML is considered as a valuable tool under equity valuation as well as comparison it shall not be
approched in the isolation as forecasted return from investment over Rf rate for return is not the
only concern while taking investment decisions (Antoniou, Doukas & Subrahmanyam, 2016).
Conversely, capital market line (CML) is a graph for required return as well as risk that is
measured through standard deviation (SD) of portfolio of risk free assets and basket associated