Explanation

The Security Market Line (SML) is a graphical representation of the Capital Asset Pricing Model (CAPM) that shows the relationship between expected return and systematic risk (beta).

Key points about the Security Market Line:

1. Applies to all securities - The SML represents the expected return for any security based on its beta. This includes both efficient and inefficient securities.

2. Based on systematic risk only - The SML plots expected return against beta (systematic risk), not total risk. Idiosyncratic risk (unsystematic risk) is not priced in the CAPM framework because it can be diversified away.

3. Efficient securities - Securities that plot exactly on the SML are considered fairly priced. Securities above the SML are undervalued (offer higher expected return for their level of systematic risk), and securities below the SML are overvalued.

4. Difference from Capital Market Line (CML) - The CML applies only to efficient portfolios (combinations of the market portfolio and risk-free asset), while the SML applies to all individual securities.

Why the other options are incorrect:

• Option B: The SML applies to all securities, not just efficient ones. Efficient portfolios are represented by the Capital Market Line (CML).
• Option C: The SML specifically relates expected return to systematic risk (beta), not idiosyncratic risk. Idiosyncratic risk is not priced in the CAPM framework.

Correct Answer: A - The security market line applies to all securities.