Explanation:
The CAPM equation is built around the SML. The SML combines a risk-free return with varying levels of systematic risk only, whereas the CML uses total risk represented by standard deviation.
If a stock has a return below the SML, it is overvalued. If it has a return above the SML, it is undervalued.
(Book 1, Module 5.2, LO 5.b)
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Question 80
Which of the following is correct regarding the capital market line (CML) and the security market line (SML)?
I. The CAPM equation is built around the CML.
II. If a stock has a return below the SML, it is overvalued.
A
I only.
B
II only.
C
Both I and II.
D
Neither I nor II.
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