馃攳
Security Market Line (SML) | Formula | Examples - YouTube
Channel: WallStreetMojo
[10]
hello everyone hi welcome to the channel
of WallStreetmojo watch the video
[15]
till the end and if you're new to this
channel then you can subscribe us by
[20]
clicking the bell icon friends today
we're going to learn a concept that is
[24]
on security market line this concept
exactly it comes into picture when
[32]
you're trying to evaluate the portfolio
management of different stocks now as
[36]
you can see there's a graph over here
which is visible see what is security
[40]
market line near here you can see their
line over here which is written but what
[44]
exactly does it mean see a similar that
is the security market line is basically
[49]
a graphical representation of the
capital asset pricing model now what is
[56]
your capital as a pricing model it is as
simple as that your cost of equity the
[61]
amount of the cost that you need to pay
to your equity shareholders right so you
[68]
calculate your key based on the CAPM
method and this is the representation of
[73]
the CAPM SML Q's an expected return of
the market at the different level of the
[78]
systemic or the market risk and it is
also called as the characteristics line
[82]
where X represents the beta
that is the systematic risk beta a risk
[90]
of the asset and the y-axis represents
the expected return er right so over
[98]
here above the security market line you
see undervalued stocks that means a buy
[103]
signal and below the security market
line you have a valued stocks which
[108]
shows as the sell signal because over
there
[112]
you cannot go further it's gonna go down
it's all value so the security market
[117]
line equation goes something like this
SML is equal to your expected return
[124]
which is equal to RF that is the
risk-free rate plus your bita okay you
[132]
open the bracket okay the big one
today you have expected
[140]
you have expected return from the market
ERM less TRS that is the risk-free rate
[149]
and you close the practice this is your
SML okay so in this above security
[155]
market line you see er is the expected
rate of return as you can see expected
[160]
rate of return RF is the over here this
is not EF this is RF
[166]
okay this is RF that is risk-free
rate then you have beta which is the
[171]
sensitivity of the stock which is non
diversifiable or systemic risk and the
[175]
most important factor of SML and erm is
basically the expected return on the
[181]
market portfolio and finally you have RF
which is known as ARM minus RF this
[189]
whole thing is also known as your market
risk premium the above security market
[194]
line equation can be graphically also be
represented you can see how the
[199]
graphical representation has been done
market risk premium
[202]
ERM minus RF that is your risk free rate
is down you can see the straight line
[208]
M is the market portfolio this is the
security market line you have above
[213]
under value stocks and below as
overvalued stocks expected written over
[217]
here on the y axis insist systematic
risk on the x axis let us understand
[223]
some characteristics of the same see
assimil is a good representative of
[227]
investment opportunity cost which
provides a combination of it's a combo
[232]
offer you can see a risk-free date that
is your RF and the market portfolio okay
[240]
second 0 beta 0 beta security or 0 beta
portfolio has an expected return on the
[249]
portfolio which is equal to RF okay
third the slope of SML SML the slope and
[260]
symbol is determined by the market risk
premium which is erm - your RF that is
[268]
risk premium higher the market risk
premium steeper the slope and vice versa
[272]
the case for the asset which are above
which are above SML are basically you
[283]
can say overvalued
as they have lower expected return for
[288]
the same amount of the risk then the
next thing that you have a security
[293]
market line example which we are going
to understand let's say that the
[297]
risk-free rate
RF is 5% okay and the expected market
[306]
return erm is let's say 14% consider
there are two securities one with a beta
[313]
okay one with a beta of 0.5 let's say
there is security a and the security P
[320]
let's just take up our control X control
V you have beta of two companies and
[327]
this is going to remain the same control
V control okay so your beta for the two
[333]
security let's say 0.5 and 1.5 right so
now let us understand the security
[340]
market line example calculating the
expected return on each security using
[343]
SML see the expected return for security
a s for the security market line is is
[350]
as simple as that is equal to your
risk-free rate that is 5% plus
[355]
you will have you will multiply 0.5 x 9
okay
[362]
that is 14 -5 you can I'll just
do it in bracket 14 - 5 that is your
[367]
ERM- RF so that's 9.5
okay and in the similar fashion you can
[374]
find 4 this is equal to 5% that is
the risk-free rate plus 1.5
[379]
that is the beta as you can see into 9
that is again the same thing there's no
[386]
change so you can see there is a
significant change just because of the
[389]
beta 0.5 and 1.5 and 9.5 and 18.5
[393]
can see the significant level of
difference just because of the change in
[396]
the beta higher the beta has led to
higher amount of the cost of basically
[402]
the cost of equity
now what is the important measure in the
[407]
security market line what is the
important measure in the security market
[413]
line see beta is important measure in
the
[417]
security market line thus let's discuss
in detail
[422]
you know beta is is a measure of
volatility of the systemic risk or
[426]
security of the portfolio as compared to
the market as a whole so the market can
[430]
be considered as an indicative market
index or a basket of universal assets if
[435]
your beta if that is equal to 1 then the
stock has the same level of same level
[445]
of you can say risk same level of risk
of the stock to the market a beta
[452]
greater than 1 represents that the stock
has written in 1 represents a risky
[457]
riskier asset than the market and beta
less than 1 when we say that if beta is
[465]
less than 1 that represents that risk is
less than the market right and the beta
[472]
can be calculated by a very simple
formula that is the covariance of x and
[478]
y or let's say the risk from the market
and the risk from the stock divided by
[485]
the variance of market becomes a
variance of the RM that is of the market
[493]
or you can this this can be written as
the correlation which is a P you can say
[502]
Ms okay you will multiply this into your
standard deviation SD of stock upon st
[514]
of market that is the standard deviation
of the market let's understand some of
[520]
the advantages and some of the
disadvantages of security market line
[525]
see the security market line is very
easy to use SML and cape am can be
[532]
easily used to model and derive expected
return from the asset of the portfolio
[535]
second D model assumes that the
portfolio is well diversified
[541]
well diversified hence it neglects the
unsystematic risk making - easier to
[546]
compare to reference to diversified
portfolio third CAPM in SML considers
[552]
systemic risk systemic risk and which is
negated by other models like dividend
[561]
discount model and weighted average
model so based on this we can mix and
[566]
find the conclusion SML it gives a
graphical representation of the capital
[571]
asset pricing model to give expected
return for the systemic or the market
[575]
risk fairly price portfolio like SML
while undervalued and overvalued stock
[581]
okay portfolio lies between the below
and and below the line respectively a
[586]
risk averse investor you can say that
investment is more often to lie close to
[592]
the y-axis or the beginning of the line
where ever risk-taker investors
[598]
investment would be higher on the SML
and SML provides a good method for
[602]
comparing the two investments or
securities however the same depends on
[606]
the assumptions of the market risk
risk-free rate and the beta coefficients
[612]
if you have learnt and you know liked
with the video if you think that you
[617]
know if you have enjoyed and learned
watching this video please like comment
[621]
on this video and subscribe to our
channel for all the latest updates
[624]
thank you everyone Cheers
Most Recent Videos:
You can go back to the homepage right here: Homepage