The CAPM contends that there is systematic and unsystematic risk for an individual security. Which is...

The CAPM contends that there is systematic and unsystematic risk for an individual security. Which is the relevant risk variable and why is it relevant? Why is the other risk variable not relevant?
Requirements: 250

Expert Solution

The risk is the degree of uncertainty to which a portfolio is exposed. Total risk of a portfolio consists of -

Systematic Risk
Unsystematic Risk

Systematic risk is the probability of occurrence of loss existing in the stock market. It is inherent risk but it can be controlled.

Unsystematic risk is an industry specific or firm specific risk. It is also called Specific risk/ residual risk. It is possible to eliminate unsystematic risk through diversification of portfolio

In CAPM the relationship between systematic risk and expected return for portfolio is described. So in CAPM the relevant risk variable is systematic risk. This risk is relevant because it can not be eliminated but controlled (as stated above). The unsystematic risk on the other hand is not relevant because of the possibility of elimination it carries.

For further clarification

CAPM formula uses Beta factor to find out expected return. Beta factor is a measure of systematic risk arising from exposure to general market movements

jeff jeffy answered 4 months ago

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