ECONOMICS
RISK AND RETURN
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Question
[CLICK ON ANY CHOICE TO KNOW THE RIGHT ANSWER]
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Both market risk and diversifiable risk is being compensated
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Beta depends on the perceived risk of thestock market and the investors’ degree ofrisk aversion
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ri = rRF + (rM-rRF) bi
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Only market risk is being compensated
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Beta measures h ow sensitive is the stock to market-wide riskfactors
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Detailed explanation-1: -The capital asset pricing model (CAPM) is an idealized portrayal of how financial markets price securities and thereby determine expected returns on capital investments. The model provides a methodology for quantifying risk and translating that risk into estimates of expected return on equity.
Detailed explanation-2: -Beta (), primarily used in the capital asset pricing model (CAPM), is a measure of the volatility–or systematic risk–of a security or portfolio compared to the market as a whole.
Detailed explanation-3: -Beta measures a stock’s sensitivity to market risks. Investors expect aggressive stocks to outperform the market in periods of strong economic activity. Defensive stocks typically provide better returns during periods of economic downturn since they are not very sensitive to market fluctuations.
Detailed explanation-4: -The CAPM is based on the assumption that all investors have identical time horizon. The core of this assumption is that investors buy all the assets in their portfolios at one point of time and sell them at some undefined but common point in future.