Security Market Line

The security market line is the graph of CAPM. It plots required return on the vertical axis against beta on the horizontal axis. It starts at the risk-free rate when beta is zero and rises by the equity risk premium for each unit of beta.

With a 5% risk-free rate and a 5% premium, the line passes through 5% at beta 0, 10% at beta 1.0 and 11% at beta 1.2. A stock whose expected return plots above the line looks underpriced, and one below it looks overpriced.

The slope is the equity risk premium, so a higher premium makes the line steeper. Read more under required rate of return and the capital asset pricing model. The FAQ on the required rate of return explains expected versus required return.