Explain why all securities should normally be priced to fall on the security mar

Question

Explain why all securities should normally be priced to fall on the security market line: Bond problem Given the following: a 10 year corporate bond with a $1,000 par value, The coupon rate is 6%. If you own the bond for 4 years, and al the end of 4 years market interest rates are 7%, you then decide to sell the bond: Calculate the new price of the bond: What is the current yield: If you did not sell the bond, and you had originally bought the bond for $1,000, what would the YTM be at the bond's maturity? List in order, the generally accepted "required returns" of the following 5 securities, from high to low (Corporate bonds, small company stocks, large company stocks, treasury bills, & govt., bonds):

Explanation / Answer

Security Market Line is also called the Characteristic Line. It is the Line Which shows the Beta(Risk Factor) and Expected Return. it determines the Market Risk premium which is the Difference of Market Return and the Risk free rate of return. So SML is the point of Break Even below which securites should not be priced.

It is a useful tool in determining whether an asset should be considered for a portfolio or not. Whether it would be able to give reasonable return for the risk involved or not. If security risk and return is plotted above the SML then it is undervalued, and the investor can expect a greater return for the inherent risk. And they are plotted below the SML then the securities are Overvalued and Investor would be expecting less return for the Risk involved.

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