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

Solutions

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 1 month ago

Next > < Previous

Related Solutions

Q1. The Total Risk of an Individual Share Comprises Both Systematic and Unsystematic Risk. How are...

Q1. The Total Risk of an Individual Share Comprises Both Systematic and Unsystematic Risk. How are these Affected by increasing the Number of Shares in a Portfolio? (approx 200 word) Q2. Why are Investors Only Focused on Market Risk When Applying the Capital Asset Pricing Model (CAPM) to Price Risk Securities? (approx 200 word)

(i) Which security has greater total risk? Which has greater systematic risk? Which has greater unsystematic risk? Which security will have a higher risk premium?

(i) Which security has greater total risk? Which has greater systematic risk? Which has greater unsystematic risk? Which security will have a higher risk premium?(ii) Construct a two-asset equally weighted portfolio is minimising the overall risk. What is the portfolio's Beta? What is the standard deviation of the portfolio?(iii) Calculate the Sharpe ratios for the three securities and the equally weighted portfolio in part ii. Is it possible to build a two-asset equally weighted portfolio with a higher Sharpe ratio...

Discuss the advantages and disadvantages of using the CAPM as itpertains to systematic and unsystematic...

Discuss the advantages and disadvantages of using the CAPM as it pertains to systematic and unsystematic risk. This is for a Financial Management course.

Types of Risk Explain the differences between total risk, unsystematic risk, and systematic risk. Identify which...

Types of Risk Explain the differences between total risk, unsystematic risk, and systematic risk. Identify which risk is measured by standard deviation and which is measured by beta. Please explain indepth.

Explain the differences between total risk, unsystematic risk, and systematic risk.

Explain the differences between total risk, unsystematic risk, and systematic risk. Identify which risk is measured by standard deviation and which is measured by beta.

Explain the CAPM. [hint: we need to discuss systematic and unsystematic risks, diversification, assumptions CAPM makes,...

Explain the CAPM. [hint: we need to discuss systematic and unsystematic risks, diversification, assumptions CAPM makes, SML line, the model, things CAPM can't explain, etc. ]

Discuss systematic risk and unsystematic risk, and how they are measured. Is it possible to neutralize...

Discuss systematic risk and unsystematic risk, and how they are measured. Is it possible to neutralize or lessen the effects of each of these risks? If yes, how can this be accomplished?

Risk can be subdivided into systematic and unsystematic risk. Describe each type of risk, the related...

Risk can be subdivided into systematic and unsystematic risk. Describe each type of risk, the related compensation for bearing that risk, and give some examples of each type.

1) explain the importance of systematic risk and unsystematic risk in risk managament? 2) Discuss the...

1) explain the importance of systematic risk and unsystematic risk in risk managament? 2) Discuss the positive and negative aspects of systemstic risk and unsystematic risk?

1. difference between systematic and unsystematic risk? 2. how does diversification reduce unsystematic risk? 3. what...

1. difference between systematic and unsystematic risk? 2. how does diversification reduce unsystematic risk? 3. what does CAPM mean? 4. how risk free asset can influence portfolio expected risk and return perspective? 5. why does the investment theory talk about optimal portfolio?

Subjects