model based on the proposition that any stocks required rate of return is equal to the risk free rate of return plus a risk premium that reflects only the risk remaining after diversification

also called unsystematic or company risk

a type of risk that can be diversified away

also called systematic or market risk

Type of risk that cannot be eliminated by diversification

measure of risk when assets are held in portfolio

rate of return that an investor would require in a riskless investment. This is composed of the real rate and inflation premium.

expected rate of return of the market as a whole

difference between market rate of return and the risk free rate

is the return required as compensation to investors for taking risk

a graphical representation of CAPM

Capm uses _______ as a measure of risk

Risk free rate is composed of

provides a general framework for analyzing risk return relationship for all types of assets

CAPM uses only one part of the total risk called

represents essentially random events like; lawsuits, strikes, company management, marketing strategies etc.

affecting market as a whole, it affects all firms simultaneously like; wars, inflation, interest rates, etc.

measure of sensitivity of a security's return relative to the returns of a broad based market portfolio securities

measures co-movement between a stock and the market portfolio

as the one tends to move up and down in step with the general market as measured by some index

represents the linear relationship between a security's required rate of return and its risk as measured by beta.

minimum rate of return required for a project to be accepted

Assumptions about investor behavior include: - Investor are risk averse and expected to be rewarded - Investors act rational - Investors made decision on a single time horizon - Investors same the share expectations

Assumptions about the securities market include: - All investors can borrow or lend unlimited amount - Financial markets are frictionless ( no taxes/transaction costs) - All assets are perfectly divisible and perfect liquid - Information is freely available to all investors

Is it advisable for an investor to just hold a portfolio consisting all stocks? Probably not, because of the following reasons: - entails high administrative costs -Index fund can be used for diversification - Some people they can "beat the market" - Some people believe they can find and buy undervalued stocks and sell overvalued ones.

Systematic risk can be measured by a stock's beta coefficient

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