“If markets are in equilibrium, risk and return combinations for individual securities will lie along the SML, but not along the CML. Risk and return combinations for individual securities will lie below the CML because their standard deviations include unsystematic risk that is diversified away in the market portfolio.” Source: Reading 60 Schweser pg 175 (middle of page)

Does this mean the expected return has decreased if the same security were to be plotted in the CML graph? For example, if the expected return of the security when plotted in the SML is 10% (given the same scale of expected returns for both CML and SML) - the same security will now lie below the CML - so, does this mean the expected return now is below 10%? I am confused because if the ‘unsystematic risk’ in CML is diversified away then essentially it’s the market portfolio - which is ALSO synonymously represented by the SML.

Securities that plot on the CML are efficient, the only risk left is systematic risk, all unsystematic risk is gone. So, an individual security which is not fully deversified will not be efficient, so it will not plot on the CML. Yes, it will have a lower return than an efficient security for the same amount of risk.

Ah right … securities plotting on the SML and CML are all efficient securities which do not face unsystematic risk. SML has only systematic risk since it uses beta - however, CML uses standard deviation which equals both systematic and unsystematic risk.

So, if unsystematic risk has not been fully diversified away we can expect the security to plot below CML BUT this same security will plot on the SML with an assumption that it now fully diversified facing only systematic risk. Is this correct.

Sounds good to me, but that’s just my understanding.