Understanding Beta and Market Risk

📋 Course Outline

1. CAPM overview
2. Risk-Return relationship
3. Systematic and Unsystematic Risks
4. Expected Return Calculation
5. Historical and Probabilistic Methods
6. CAPM Formula Components
7. Beta and Market Sensitivity

📖 1. CAPM overview

🔑 Key Concepts & Definitions

• Capital Asset Pricing Model (CAPM): A fundamental financial tool used to calculate the expected return of an asset, reflecting the compensation investors demand for the risk associated with the investment in relation to the broader market.
• Purpose of CAPM: To estimate the appropriate rate of return for an investment, often called the required rate of return, enabling investors to evaluate whether an asset is worth its current price by comparing expected return to risk involved.
• Use of CAPM to estimate required rate of return: The model provides a formula that incorporates the risk-free rate, a measure of an asset’s sensitivity to market movements (beta), and the market risk premium, to determine the minimum acceptable return for an investment.
• Role of CAPM in stock valuation: It helps in assessing whether a stock’s expected return justifies its risk level, guiding decisions on buying or selling based on how expected returns compare with perceived risks.
• Comparison of expected return to risk involved: The model emphasizes that higher risks should be compensated with higher returns, aligning expected returns with the level of market-related risk…