Answer: Systematic risk only.

## Explanation The Capital Asset Pricing Model (CAPM) states that investors should only be compensated for **systematic risk** (also known as market risk or non-diversifiable risk). Here's why: ### Key Concepts: - **Systematic Risk**: Risk that affects all companies in the market and cannot be eliminated through diversification (e.g., interest rate changes, inflation, recessions, political instability) - **Unsystematic Risk**: Risk specific to individual companies or industries that can be eliminated through diversification (also called specific risk, diversifiable risk, or idiosyncratic risk) ### Why Only Systematic Risk is Compensated: 1. **Diversification Principle**: CAPM assumes investors hold well-diversified portfolios 2. **Elimination of Unsystematic Risk**: Through diversification, unsystematic risk can be completely eliminated from a portfolio 3. **Market Efficiency**: Only non-diversifiable risk should be priced by the market ### Why Other Options Are Incorrect: - **Option B**: Investors are NOT compensated for unsystematic risk since it can be diversified away - **Option C**: CAPM specifically states compensation is only for systematic risk, not both - **Option D**: Asset-specific risk is a type of unsystematic risk and therefore not compensated The CAPM formula itself (E(Ri) = Rf + βi(E(Rm) - Rf)) reflects this principle, where beta (β) measures only systematic risk exposure.

Author: Tanishq Prabhu