What does the capital asset pricing model (CAPM) focus on in risk assessment?

What does the capital asset pricing model (CAPM) focus on in risk assessment?

• A. The total market risk of the stock.
• B. The volatility of returns of competing stocks.
• C. The sole relationship of beta to cost of equity.
• D. The relationship between market risk and returns is non-linear.

Answer: (C)

The capital asset pricing model (CAPM) is a finance theory that establishes a linear relationship between the expected return of an investment and its risk, measured by beta. The key focus of CAPM is on how the risk associated with a particular security, represented by beta, correlates with the expected return. Beta measures the sensitivity of a stock's returns relative to the returns of the overall market, making it an essential component in assessing the cost of equity for that stock. By emphasizing the relationship of beta to the cost of equity, CAPM simplifies the assessment of risk, enabling investors to use beta as an indicator for how much risk an investment carries in relation to market movements. This focused perspective on beta allows for a clear understanding of risk-adjusted returns and helps in determining an appropriate discount rate for future cash flows. In contrast, the other options touch on broader or different aspects of risk assessment that are not the central tenet of CAPM. Total market risk refers more to the systematic risk that affects the entire market, while volatility among competing stocks is not directly addressed within the CAPM framework. The idea that the relationship between market risk and returns is non-linear is also inconsistent with CAPM, which posits a linear relationship between the expected return

The capital asset pricing model (CAPM) is a finance theory that establishes a linear relationship between the expected return of an investment and its risk, measured by beta. The key focus of CAPM is on how the risk associated with a particular security, represented by beta, correlates with the expected return. Beta measures the sensitivity of a stock's returns relative to the returns of the overall market, making it an essential component in assessing the cost of equity for that stock.

By emphasizing the relationship of beta to the cost of equity, CAPM simplifies the assessment of risk, enabling investors to use beta as an indicator for how much risk an investment carries in relation to market movements. This focused perspective on beta allows for a clear understanding of risk-adjusted returns and helps in determining an appropriate discount rate for future cash flows.

In contrast, the other options touch on broader or different aspects of risk assessment that are not the central tenet of CAPM. Total market risk refers more to the systematic risk that affects the entire market, while volatility among competing stocks is not directly addressed within the CAPM framework. The idea that the relationship between market risk and returns is non-linear is also inconsistent with CAPM, which posits a linear relationship between the expected return