What does it indicate if a security price is below the SML?

When a security's price is below the Security Market Line (SML), it indicates that the security is overpriced. The SML represents the expected return of an asset based on its systematic risk, measured by beta. If a security is priced below this line, it suggests that the return it offers is not adequate relative to the risk taken, indicating that investors are not being compensated properly for the risk associated with that investment.

In this context, when a security is underpriced, it would typically be found above the SML, as it would imply a higher expected return for a given level of risk, thus representing an attractive investment opportunity. Since the question refers specifically to a scenario where the security price is below the SML, this would lead to the conclusion that the security is indeed overpriced, thereby making the actual return less favorable compared to the anticipated return dictated by its risk.

Understanding the SML and the risk-return relationship is central to the Capital Asset Pricing Model (CAPM), helping investors assess whether they are receiving an appropriate return for the risk they are undertaking.