According to the CAPM, the expected return on a stock, that is part of a portfolio, will depend on all of the following except:

By Investopedia AAA
A:

A. the covariance between the stock and the market.

B. the variance of the market.

C. the market risk premium.

D. the stock's correlation with the other securities in the portfolio.


The general idea behind capital asset pricing model (CAPM) is that investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of time and to the market premium (Rm-rf). Beta is the the covariance between the stock and the market divided by the variance of the market.

Correct answer: D. the stock's correlation with the other securities in the portfolio.

RELATED FAQS

  1. How do financial markets react to recessions?

    Learn more about the relationship between recessions and financial markets by identifying the fundamental characteristics ...
  2. How do banks measure the Five Cs of Credit?

    Learn about the five C's of credit and what qualitative and quantitative methods banks use to measure them when evaluating ...
  3. How do drawdowns help assess investment risk?

    Learn how the concepts of drawdowns and maximum drawdowns are used in the analysis of risk, as well as in the building of ...
  4. How do I find out my own risk tolerance?

    Learn why risking capital can be risky business, how much risk can you afford and how to determine the right amount of risk ...
RELATED TERMS
  1. Risk Financing

    The determination of how an organization will pay for loss events ...
  2. Captive Value Added (CVA)

    The financial benefit that an organization would gain by using ...
  3. Sharpe Ratio

    A ratio developed by Nobel laureate William F. Sharpe to measure ...
  4. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  5. Annuity

    A financial product that pays out a fixed stream of payments ...
  6. Einhorn Effect

    The sharp drop in a publicly traded company’s share price that ...

You May Also Like

Related Articles
  1. Bonds & Fixed Income

    A Look at the Pros and Cons of Muni ...

  2. Bonds & Fixed Income

    How to Diversify with Muni Bond ETFs

  3. Investing Basics

    What are examples of popular companies ...

  4. Technical Indicators

    Strategies To Trade Volatility Effectively ...

  5. Fundamental Analysis

    How Investment Risk Is Quantified

Trading Center