Question

a) Explain the concepts of variance (total risk) and beta (systematic risk) in portfolio theory and...

a) Explain the concepts of variance (total risk) and beta (systematic risk) in portfolio theory and the capital asset pricing model. b) Discuss why according to the capital asset pricing model that total risk should not be rewarded by the capital market. You may use diagrams in your explanation if you wish.

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Answer #1

Part A:

Total Risk = Systematic Risk and Unsystematic Risk

Systematic risk is associated with market and it is common for all companies in same industry. This risk at macro level.

Unsystematic risk is company specific.

Beta 2 for a company means, Systematic risk of company is two times to systematic risk of market.

PArt B:

According to CAPM Model,. Expected Return = Risk Free Ret + Beta ( Market Ret - Risk free Ret )

Beta is Systematic Risk.

While computing Expected Ret in CAPM, You are supposed toexpect Premium return for Sysytematic Risk. Because Unsystematic risk Organiozation specific and can be made to Zero through proper diversificaton strategy.

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