Explain what CAPM stands for and how it operates. In your answer discuss the importance and...

Explain what CAPM stands for and how it operates. In your answer discuss the importance and significance of systematic and nonsystematic risks

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Expert Solution

CAPM = Capital Asset pricing model.

Risk Means deviation from expected ret. It is measured with "SD".
SD specifies Total Risk
Total Risk can be classified into two
1. Systematic Risk - Risk associated with Market
2. Unsystematic Risk - Risk that is organization specific.

Systematic risk is market specific and can't be avoided.

Unsystematic risk is firm specific and can be avoided through proper diversification strategy.

Thus CAPMconsiders risk premium for systematic risk alone.

CAPM Ret = Rf + Beta ( Rm - Rf )

Rf = Risk free ret
Rm = Market ret
Rm - Rf = Risk Premium
Beta = Systematic Risk

jeff jeffy answered 2 years ago

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