Financial Risk Manager Part 1

A security that is plotted above the Security Market Line (SML) on a chart is considered undervalued and a profitable buy for investors. The SML is a representation of the Capital Asset Pricing Model (CAPM), which is used to determine the appropriate required rate of return of an asset. If a security is plotted above the SML, it means that the security's expected return is greater than the required return given its level of risk as per the CAPM. This indicates that the security is undervalued, as it is providing a higher return than what would be expected given its risk level. Therefore, it would be a profitable buy for investors, as they would be receiving a higher return for the level of risk they are taking on.

Choice B is incorrect. An overvalued security that plots above the SML would not be a profitable buy for investors. Overvalued securities are typically considered to be priced higher than their intrinsic value, meaning that they may not provide a good return on investment.

Choice C is incorrect. While an undervalued security could potentially be a profitable short sell if its price were expected to decrease, this scenario contradicts the assumption of the SML and CAPM models which suggest that securities plotted above the SML are providing higher returns than expected given their level of systematic risk, indicating they are undervalued and therefore likely to increase in price.