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. What is the utility function and how is it calculated?

    Learn what the utility function is in microeconomic theory and how it is calculated based on a functional form that represents ...
  2. Does index trading increase market vulnerability?

    Learn how the rise in popularity of passive ETFs and mutual funds tracking indexes has increased the correlation among stocks, ...
  3. What does a high turnover ratio signify for an investment fund?

    Find out more about the turnover ratio, what the turnover ratio measures and what a high turnover ratio indicates about an ...
  4. What is the difference between passive and active asset management?

    Find out about active asset management, passive asset management, how these strategies are utilized and the differences between ...
RELATED TERMS
  1. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  2. Financial Singlularity

    A financial singularity is the point at which investment decisions ...
  3. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  4. Revenue-based Financing

    Revenue-based financing, also known as royalty based financing, ...
  5. Systematic Manager

    A manager who adjusts a portfolio’s long and short-term positions ...
  6. Unconstrained Investing

    An investment style that does not require a fund or portfolio ...

You May Also Like

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P 500 Trust

  2. Professionals

    Is a Google Robo-Advisor on the Horizon?

  3. Mutual Funds & ETFs

    ETF Analysis: Energy Select Sector SPDR

  4. Trading Strategies

    Adjust Market Strategies To Elevated ...

  5. Fundamental Analysis

    What does a high turnover ratio signify ...

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!