Which statement about CAPM is true?

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Multiple Choice

Which statement about CAPM is true?

CAPM links an asset’s expected return to its systematic risk, measured by beta, using the formula E[R] = R_f + β(E[R_m] − R_f). Here R_f is the risk-free rate, E[R_m] is the market’s expected return, and (E[R_m] − R_f) is the market risk premium. This means higher beta — greater sensitivity to market movements — requires greater compensation above the risk-free rate. The statement is true because it exactly reflects this formula: the expected return equals the risk-free rate plus beta times the market risk premium. CAPM does not fit the other ideas: beta is central, a risk-free asset is assumed for lending/borrowing, and it does not use the dividend discount rate to estimate returns. For example, with R_f = 3%, market return 9% (market risk premium = 6%), and beta = 1.5, the expected return would be 3% + 1.5×6% = 12%.

CAPM links an asset’s expected return to its systematic risk, measured by beta, using the formula E[R] = R_f + β(E[R_m] − R_f). Here R_f is the risk-free rate, E[R_m] is the market’s expected return, and (E[R_m] − R_f) is the market risk premium. This means higher beta — greater sensitivity to market movements — requires greater compensation above the risk-free rate. The statement is true because it exactly reflects this formula: the expected return equals the risk-free rate plus beta times the market risk premium. CAPM does not fit the other ideas: beta is central, a risk-free asset is assumed for lending/borrowing, and it does not use the dividend discount rate to estimate returns. For example, with R_f = 3%, market return 9% (market risk premium = 6%), and beta = 1.5, the expected return would be 3% + 1.5×6% = 12%.

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