Financial Risk Manager Part 1
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According to the CAPM, the risk premium expected to be received by a stockholder increases:
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A
Directly with beta.
B
Inversely with beta.
C
Inversely with systematic risk.
Explanation:
Explanation
According to the Capital Asset Pricing Model (CAPM), the expected risk premium for a stock is calculated as:
E(Ri) - Rf = βi × (E(Rm) - Rf)
Where:
- E(Ri) - Rf = Risk premium for stock i
- βi = Beta coefficient for stock i
- E(Rm) - Rf = Market risk premium
From this formula, we can see that:
- The risk premium is directly proportional to beta (β)
- As beta increases, the risk premium increases proportionally
- As beta decreases, the risk premium decreases proportionally
Beta measures systematic risk, which is the risk that cannot be diversified away. Therefore, the risk premium increases directly with beta, not inversely.
Correct Answer: A - Directly with beta
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