Risk, Return, and

the Capital Asset Pricing Model

John Marron
 RISK
Total Risk = Systematic + Unsystematic Risk
Systematic Risk is also called Nondiversifiable
Risk or Market Risk
Unsystematic Risk is also called Diversifiable
Risk or Unique Risk
 Diversification
Can eliminate some risk
Unsystematic risk tends to disappear in a
large portfolio
Systematic risk never disappears
 Beta
Beta = How much systematic risk a
particular asset has relative to an average
asset
For example:
XOM: 0.65
VIAB: 1.22
YHOO: 3.56
MII Portfolio: 1.54
 Capital Asset Pricing Model

Er = Rf + B{E(Rm)-Rf}
Works for both individual assets
and portfolios
McIntire Investment Institute
Example:
If Rf = 5.5%
Market Risk Premium = 7%
Then the MII should return:
Er = 5.5% + 1.54(12.5%-5.5%)
Er = 16.28%
 Expected Return depends on
3 things
• The time value of money (risk-free rate, Rf)
• The reward for bearing systematic risk
(market risk premium={E(Rm) - Rf}
• The amount of systematic risk (Beta)