In Chapter 8, Mayo (2019) discussed the relationship between risk and required return and referenced the...

In Chapter 8, Mayo (2019) discussed the relationship between risk and required return and referenced the capital asset pricing model (CAPM) as a method for investors to value an asset’s expected return. Write a short essay (300 words or less) to explain the CAPM concept and discuss the interrelationship of its three components in accounting for systematic and unsystematic risk. You may supplement your answer using outside sources. Please no cursive pictures.

Expert Solution

Capital Asset pricing model is a model in order to find out the expected rate of return which is associated with it and it will be providing a with risk free rate along with beta of the assets which will be representative of the systematic risk associated with asset and we will also be considering risk premium which will be representative of the difference between the risk free rate and the market rate of return.

Capital Asset pricing model is having an unique element of identification of the risk by determination of the beta associated with the portfolio because beta will be reflective of the systematic risk or market risk which can never be managed while Capital Asset pricing model will be arguing that the unsystematic risk associated with the portfolio is already managed and the portfolio is well diversified in advance so it can be said that it is only considering systematic risk in order to find out the required rate of return which an investor will be demanding in order to compensate for the risk undertaking by purchasing an asset so he will be trying to ascertain his overall expected rate of return in relation to to risk free rate and market rate of return.

it will be assumed that unsystematic risk is completely eliminated in the portfolio and only systematic risk will be existent in the portfolio which will help in finding out the expected rate of return.

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