Final answer:
A stock with an actual return above the security market line does not necessarily have more systematic risk than the overall market; it has performed better than expected for its level of risk, providing investors with higher returns as compensation for the risk undertaken.
Step-by-step explanation:
A stock with an actual return that lies above the security market line (SML) is typically considered to offer a higher return for its level of systemic risk when compared to the overall market. The SML represents the expected return of a security based on its systematic risk, also known as market risk or non-diversifiable risk, as measured by beta. It is a key aspect of the Capital Asset Pricing Model (CAPM).
In the investment world, it is acknowledged that higher risk is associated with the potential for higher returns. Stocks, due to their volatility, offer the potential for such higher average returns over an extended period when compared with bonds and savings accounts, which carry lower risk and, therefore, typically lower returns.
Therefore, when a stock performs better than what the SML predicts, it means the investment has compensated investors with higher returns for the risk undertaken. However, it does not necessarily indicate the stock has more systematic risk than the overall market; rather, it implies that the stock's actual performance has exceeded the expected risk-return trade-off as defined by the SML.