Relationship in expected return for assets-systemic risk

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The Capital Asset Pricing Model describes the relationship between expected return for assets (particularly stocks) and systemic risk. It is used widely for pricing of risky securities. The idea behind CAPM is that investors need to be compensated in two ways - time value of money and risk. Expected Return of an Asset = Risk Free Rate + Beta of the security (Expected Market Return - Risk Free Rate) Time value of money is using the risk-free rate (rf) and compensates investors for placing money over a period of time. The risk-free rate is typically the yield on government bonds. The other part of it is calculating the amount of comensation an investor needs for taking on the additional risk. The beta compares the returns of the asset to the market over a period of time and to the market premium - comparing how risky it is to overall market risk. The CAPM says that the expected return of a security = the rate on a risk free securty + a risk premium. If the expected return does not meet or beat the required return then it would be a bad investment and should not be undertaken.

Reference no: EM131311472

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