 Hello and welcome to the session. This is Professor Farhad in which we would look at the security market line. The security market line is really an extension of another topic that we looked at earlier, which is the capital asset pricing model. This topic is covered on your CPA, BEC exam, as well as CFA. The reason I kept the security market line separate because it's another reinforcement of this CAPM, so I didn't want to keep on going with CAPM. I explained CAPM. Let me show you CAPM now visually. This topic is covered on the essentials or principles of investment course as well, graduate and undergraduate. As always, I'm going to remind you to connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1,800 plus accounting, auditing, finance, tax, as well as Excel tutorial. If you like my lectures, please like them and share them. If they benefit you, it means they might benefit other people. Connect with me on Instagram. On my website, farhadlectures.com, you will find additional resources to complement and supplement your courses, this course, as well as your other accounting and finance courses. I strongly suggest you check out my website. So on the prior session, we looked at the capital asset pricing model CAPM, and this is the formula for CAPM. So let's do a review real quick. It's very important. Basically, to find the expected return of your stock is you will take the risk free rate, plus what you do is you look at your market risk premium, which is your expected return on that on the market minus the risk free rate. And you multiply this by the beta of the stock, whatever the beta of the stock is, each stock will have a different beta. And all of this is called the risk premium. All of this is called the risk premium. So the risk premium multiplied by the beta, and you would always add the risk free. So simply put, it's risk free plus risk premium is what you expect to get from your investment. Now, let's visually plot CAPM. What is, what's basically CAPM? Simply put, what's basically CAPM? Looks, it looks something like this. We're going to have expected return on the x-axis and we're going to have beta on the y-axis. And what's going to happen is we're going to have risk free rate. Risk free rate is right here. And we are going to draw a line that looks like this. And this is basically CAPM visually. Now, hold on a second. This looks like something we learned before. Yes, you have to be very careful. Let me draw this other line, this other graph in another color. We looked at something very similar, expected return. We have a risk free and we have, we had an upward, upward, upward slope like this. But on the x-axis, if you remember, we had the standard deviation. Now don't confuse this one with this one. Today, we're talking about this one right here. This one is called the security market line, SML, SML. And what we have on the x-axis is beta. What is beta? Beta is the systematic risk, is the market risk. And this is what represent CAPM. This one here, the second graph that I just draw, it's very similar. This is called the capital market line or the capital allocation line. You could use either or. But remember, on the x-axis, we have total risk, which is beta and unsystematic risk, which is systematic and unsystematic risk. Just don't confuse the two. Make sure there's a difference between the two, big difference, and that's the x-axis. CAPM is with beta, so we are dealing with beta. So notice CAPM is upwardly slope. Of course, it's upwardly slope because the more risk we take, the more market risk we take, the higher is our expected return. And this is the idea of CAPM. So basically what we're looking at is CAPM visually. That's what we're doing right now. So it tells you how much reward you expect to have giving a certain beta. And the higher that beta, the higher the beta, the higher your expected return. Of course, because what's affecting your stock is how you react to the market. And one more thing I want to talk to you about capital allocation line. Remember, the capital allocation line hits the, let me add in a good job drawing. Let me do this, hits the, I'm not good at drawing, hits the efficient frontier. You guys remember the efficient frontier, tangent. This is the tangent point. And this is the point where we have the higher sharp ratio, you know, risk to reward. So this is what now we're talking about. We're talking about the security market line. So this is a visual of the security market line. And on the security market line, we have something very interesting when, when our beta equal to one, when we draw this line, for example, the expected return is 14. Now the market return is 14. When your beta is higher, when your beta is 1.2, you expect to earn more. You expect to earn more. You expect to earn 15.6. So the higher your beta, the higher is your return. And I hope this makes sense. If, if the market is your risk that you are taking any extra beta, any extra market risks, any extra market risk, you would expect a higher expected return. So beta tells us what is the market, what is the market portfolio? M is the market portfolio. Now, what's the application of CAPM? How do we use CAPM? Well, again, if we talk CAPM or security market line, it provide a bench, benchmark to assess the expected return that's consumerate with asset risk. For example, if we invest, if we invest in a stock that has a data of one, we expect 14%. That's very important. It means when we pay for the stock, you will see later, when we pay for a stock, we're going to have to determine what's the risk associated with that stock because we're going to take the dividend, one model is to take the dividend plus one plus expected return of the stock. So it makes a difference what's the expected return of the stock. If the expected return is 14, it's different than if the expected return of 15. If the expected return is 15, it means we have more return, but we are taking more risk. You would notice if we're taking more risk, we'll pay less. The amount will be discounted further. So it's going to have application later. So for example, if we think Apple has a beta of one versus Facebook, Apple is less risky, then we'll, you know, then when we discount, we use a lower rate. So that's very important. Also CAPM, when we find it, it's useful for capital budgeting decision. For example, when we are determining the cutoff, the internal rate of return or the hurdle rate for certain project internally, we use this number CAPM. And it's very important for later, we're going to be using CAPM for WAC, the weighted average cost of capital, how much it's costing us of capital. And basically WAC is also used basically for IRR, for NPV and for other capital budgeting decision. So WAC is one way to estimate the expected return. How much do we expect to return? I'm sorry, not WAC. The CAPM will help us determine what should we expect to return on a certain investment. So it has a lot of good application. In the next session, what we'd look at, we'd look at CAPM and how does it relate to another model that we looked at earlier? And that's the index model. Basically, comparing those two back to back. As always, I'm going to remind you to like my recording. If you like it, share it, put it in playlist. If it benefits you, it benefits other people. And don't forget to visit my website, farhatlectures.com for additional resources for this course as well as other courses. Good luck, study hard and stay safe.