 The CML provides a precise way to compute an investor's risk for the two things. The first one is the financial capital an investor provides and the second is the market risk and investor beers. But the CML is unable completely to explain the relationship between risk and the return. You know that CML defines an investor's risk as an asset's total volatility. But an investor cannot expect to be compensated for the diversified or the unsystematic risk. Therefore CML assumes the investors to hold fully diversified portfolios for which systematic and the total risk are the same thing. So we can say that CML cannot explain the risk return relationship or the risk return trade-off for the individual risky asset which have a substantial unique risk. So what is the solution to the limitation of CML? The solution is the famous CAPM model or the capital asset pricing model. This CAPM allows an investor to evaluate risk return trade-off for both the risky portfolios and the individual risky assets. It redefines the relevant risk measure from the total volatility as just the non-diversifiable portion of the total riskiness or the total volatility which is the systematic risk. The CAPM provides a new risk measure which is normally known as the BETA. This BETA represents a securities systematic risk with reference to the market's overall riskiness. The CAPM defines risk in terms of a security BETA as we have earlier seen. This BETA basically captures non-diversifiable portion of the stock's risk relative to the market's total riskiness. If we derive the model in terms of an equation, we see that the expected risk, expected return of a security I is equal to the risk-free rate plus the BETA into expected return and minus the risk-free rate. So the expected return of a security has a linear relationship with the market riskiness. You can have an example, let's say a stock with a BETA of 1.2 has a level of systematic risk that is 20% greater than the average for the entire market. Now 1.2 BETA of a stock means the stock is on average 20% more risky than the market's overall riskiness. Here an important point to note is that the market portfolio will always have a BETA equal to 1. If we see the graph of a security market line, we can see that the graphical CAPM is generally known as the security market line as we can see on the left bottom of our screen. This CML shows a trade-off between the risk of an individual security and the expected return as a straight line with the intercept at RFR or the risk-free rate. Now come to the difference between CML and the SML. Here we have the SML graph and here we have the CML graph. We see that CML measures the riskiness by the standard deviation of the investment whereas the SML considers only the systematic component of an investment volatility. Now this systematic component is represented by BETA and in CML, the riskiness of the portfolio is measured through the portfolio's riskiness or the portfolio's standard deviation. As a consequence, CML can be applied only to the portfolios, those who are already polydiversified whereas SML is applicable to any individual asset or the collection of assets. Now come to the undervaluation or overvaluation of the assets. We see that in equilibrium, all assets and all portfolios of the assets should be plotted on the SML. This means that the estimated rate of return on such assets should be consistent with their systematic riskiness. This means that any security whose estimated rate of return is above the SML will be termed as an underpriced security and any security whose estimated rate of return is below the SML will be termed as the overpriced security. Another way is to compare the required rate of return to the expected rate of return for a specific risky asset using the SML over the specific time horizon and the investment horizon to decide whether it is an appropriate investment or not. Now a term that is alpha can also be used to differentiate an insecurity as an overvalued or an undervalued item. For that purpose, we see to have a difference between estimated returns and the expected return and this difference is termed as the alpha or alpha return. If the alpha is positive, then the stock is undervalued and if the alpha is negative, then the stock is overvalued. And in case of zero alpha, this means the stock is at the SML and it is properly valued in line with its riskiness. Not to calculate systematic risk, we have two methods to calculate the systematic risk. The first is the conceptual model in which we divide the covariance of security i and the market portfolio over the market riskiness or the standard deviation of the market portfolio. Another method to determine the systematic risk is the regression model in which in which we estimate beta through the regression model, where in the regression equation, we regress the return on security i over the time over the market returns and we get the estimate of the beta. Both models provide the same level of estimation for any given sample of RI and RM, but the preferred method is the second method or the regression method because in this method, the T statistic on the beta i estimate can be evaluated. What is the characteristic line? The systematic risk input of any individual asset is derived from the regression model that we have already seen, which is equal to the RI is equal to alpha plus beta into RM plus the error term. You see that this model is termed as the asset's characteristic line, which is a line of best fit because we derive this line as this line passes through the means returns of the security i and the secure and the market portfolio. So when this line is drawn, this represents the characteristic line and that represents the beta or systematic risk of the security.