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NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Introduction to Modern Portfolio Theory

In the Capital Asset Pricing Model, which of the following is the only type of risk for which an investor is expected to receive a risk premium?

Systematic risk, measured by beta, is the only risk rewarded with a premium under CAPM. Company-specific risk can be removed through diversification, so the market does not compensate investors for bearing it, and total risk includes that diversifiable part.

  1. ASystematic risk measured by betaCorrect
  2. BUnsystematic risk specific to the company
  3. CTotal risk measured by variance
  4. DLiquidity risk of the individual security

Explanation

CAPM assumes investors hold well diversified portfolios, so unsystematic risk is diversified away and is not rewarded. Only market-related (systematic) risk, measured by beta, earns a premium. Total risk includes diversifiable risk, so it is not priced.

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