Answer: Security market line (SML)

## Explanation The correct answer is **B. Security market line (SML)**. ### Key Concepts: 1. **Security Market Line (SML):** - The SML is a graphical representation of the Capital Asset Pricing Model (CAPM) - It plots **systematic risk (beta)** on the horizontal axis - It plots **expected return** on the vertical axis - The slope of the SML represents the market risk premium - Formula: E(R_i) = R_f + β_i × (E(R_m) - R_f) 2. **Capital Market Line (CML):** - The CML plots **total risk (standard deviation)** on the horizontal axis - It shows the risk-return tradeoff for efficient portfolios - It connects the risk-free asset to the market portfolio 3. **Capital Allocation Line (CAL):** - The CAL plots **total risk (standard deviation)** on the horizontal axis - It shows the risk-return tradeoff for any portfolio combining a risky asset with a risk-free asset ### Why SML uses systematic risk: - The SML focuses specifically on systematic (non-diversifiable) risk measured by beta - Beta measures an asset's sensitivity to market movements - In CAPM, only systematic risk is priced, as unsystematic risk can be diversified away - This makes beta the appropriate risk measure for individual securities on the SML ### Comparison Table: | Line | Horizontal Axis | Purpose | |------|----------------|---------| | **SML** | **Systematic Risk (Beta)** | Pricing individual securities | | CML | Total Risk (Standard Deviation) | Efficient portfolio frontier | | CAL | Total Risk (Standard Deviation) | Risk-return tradeoff for any portfolio | Therefore, among the given options, only the **Security Market Line (SML)** uses systematic risk (beta) on the horizontal axis.

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