security market line

Examples of security market line in the following topics:

• Defining the Security Market Line

  • The security market line displays the expected rate of return of a security as a function of systematic, non-diversifiable risk.
  • The security market line, also known as the "characteristic line", is the graphical representation of the capital asset pricing model.
  • The security market line graphs the systematic, non-diversifiable risk (stated in terms of beta) versus the return of the whole market at a particular time, and shows all risky marketable securities.
  • The security market line is defined by the equation:
  • This is an example of a security market line graphed.

• The Relationship Between Risk and Return and the Security Market Line

  • The security market line is useful to determine if an asset being considered for a portfolio offers a reasonable expected return for risk.
  • The CAPM is a model for pricing an individual security or portfolio.
  • For individual securities, the security market line (SML) and its relation to expected return and systematic risk (beta) depicts an individual security in relation to their security risk class .
  • Individual securities are plotted on the SML graph.
  • The security market line depicts the the return on a security relative to its own risk.

• Impact of the SML on the Cost of Capital

  • The security market line is a graphical representation of the capital asset pricing model that illustrates the idea that investments are priced efficiently based on the expected return and beta-value (risk).
  • Companies often turn to capital markets in order to generate funds -- using the issuance of either debt or equity.
  • An instrument plotted above the line has a high expected return and a low price.
  • This would not be an attractive market situation for a company looking to raise capital.
  • The location of a financial instrument above, below, or on the security market line will lead to consequences for a company's cost of capital.

• The Capital Asset Pricing Model

  • The key assumption here is that the market will self-correct to adjust each investment option's expected return to the relative risk of investing.
  • For a basic CAPM calculations, you would want to solve for the expected return on a security, which looks like this:
  • Through rearranging these variables, you can also take a look at the concept of the security market line (SML), which underlines a security's relationship with systematic risk and respected return in a graphical format.
  • Investors can utilize the CAPM equation and its various implications to assess a variety of market investment opportunities to diversify a portfolio and identify undervalued assets.
  • The security market line is illustrated in this graph, where an assets expected return can be visualized.

• The SML Approach

  • The market is expected to return 12% next year.
  • The beta of the security is 1.9.
  • The Security Market Line (SML) is the graphical representation of the capital asset pricing model (CAPM), with the x-axis representing the risk (beta), and the y-axis representing the expected return.
  • Another way to think about real market applications of the SML would be in terms of buying and selling securities.
  • The Security Market Line for the Dow Jones Industrial Average over a 3 year period, with the x-axis representing beta and the y-axis representing expected return.

• Managing Marketable Securities

  • This is a broad term that encompasses investments a business may make within the securities market.
  • The most common types of debt securities are corporate bonds, government bonds, and money market instruments.
  • Perhaps the most interesting marketable securities (and often the highest risk) are derivatives.
  • This image depicts a balance sheet from Proctor & Gamble, where the cash and cash equivalents, short term investments, and long term investments underline the various line items that may depict marketable securities.
  • Understand the various forms of marketable securities, and their value in corporate finance

• Commercial Paper

  • Commercial paper is a money-market security issued (sold) by large corporations to get money to meet short term debt obligations.
  • The issuer can market the securities directly to a buy and hold investor such as most money market funds.
  • The dealer market for commercial paper involves large securities firms and subsidiaries of bank holding companies.
  • Most of these firms are also dealers in US Treasury securities.
  • Circles on blue line indicate Total commercial paper; triangles diamonds on pink line indicate SEC rule 2a-7 tier-1 commercial paper; triangles on blue line indicate Asset-backed commercial paper; squares on yellow line indicate SEC rule 2a-7 tier-2 commercial paper.

• Securities Acts Amendments of 1975

  • The 1975 amendments are to establish a national market system for the nationwide clearance and settlement of securities transactions.
  • In the United States, national market systems are governed by section 11A of the Securities Exchange Act of 1934.
  • It also owns communication lines and hardware that provide real-time quotes and transaction information to all market participants from the Consolidated Tape/Ticker System (CTS), Consolidated Quotation System (CQS), and Options Price Reporting Authority (OPRA).
  • In 1972, before the SEC began its pursuit of a national market system, the market for securities was quite fragmented.
  • Define how the Securities Act Amendments of 1975 regulate U.S. stock markets

• Accounting Methodologies: Amortized Cost, Fair Value, and Equity

  • If a business holds debt securities to maturity with the intent to sell are classified as held-to-maturity securities.
  • Debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities.
  • In the investor's income statement, the proportional share of the investee's net income or net loss is reported as a single-line item.The ownership of more than 50% of voting stock creates a subsidiary.
  • The ownership of less than 20% creates an investment position carried at historic book or fair market value (if available for sale or held for trading) in the investor's balance sheet.
  • Fair value, defined as a rational and unbiased estimate of the potential market price of a good, service, or asset.

• Commercial Banks

  • A commercial bank lends money, accepts time deposits, and provides transactional, savings, and money market accounts.
  • A commercial or business bank , is a type of financial institution and intermediary that lends money, accepts time deposits, and provides transactional, savings, and money market accounts.
  • A secured loan is when a borrower pledges some asset (e.g., a car or property) as collateral for it, which then becomes a secured debt owed to the creditor who gives the loan.
  • The debt is thus secured against the collateral.
  • Some examples of unsecured loans include credit cards and credit lines.