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CFA Level I · CFA Level I Exam · Portfolio Risk and Return: Part II

In the capital asset pricing model (CAPM), the expected return on a security is most likely a function of the risk-free rate and:

The expected return depends on the risk-free rate plus a premium for the security's systematic risk, measured by beta. Unsystematic risk is diversifiable and earns no compensation, and total standard deviation mixes both risk types, so neither drives expected return in CAPM.

  1. Athe security's systematic riskCorrect
  2. Bthe security's total standard deviation
  3. Cthe security's unsystematic risk

Explanation

CAPM states that only systematic risk, measured by beta, is rewarded with a risk premium. Unsystematic risk can be diversified away, so it earns no premium. Total standard deviation includes both components, so it is not the pricing variable.

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