![]() The CML graphs the risk premiums of efficient portfolios (i.e., portfolios composed of the market and the risk-free asset) as a function of portfolio standard deviation. It is useful to compare the security market line (SML) to the capital market line (CML). The CAPM requires an extensive set of assumptions: The systematic risk of a security, which is measured by the beta coefficient of the security, is the market risk that cannot be eliminated through diversification. The Capital Asset Pricing Model (CAPM) provides a linear relationship between the required rate of return (Ri) of a security and its Systematic or undiversifiable risk as measured by the security’s beta. The Capital Asset Pricing Model (CAPM) is a general equilibrium market model developed to analyze the relationship between risk and required rates of return on assets when they are held in well-diversified portfolios. ![]() The beta of security measures the sensitivity of a security’s return to changes in the return of the market portfolio or stock market index. The systematic risk of a security is measured by a statistic known as beta. So the real risk of a security is the systematic risk as the investors can diversify the unsystematic risk by the construction of a portfolio. But systematic risk cannot be diversified away by the construction of a portfolio. The unsystematic risk of a security can be diversified away by combining different securities into a portfolio. The risk caused by such factors is known as unsystematic or specific risk. ![]() Apart from systematic risk, the variation in return of a security is also caused by some other factors which are specific to a security, like a strike in a company or the caliber of the management of a company. The risk caused by such factors is known as systematic risk. Examples of such sources of risks are changes in the interest rates and inflation of the economy, movement of stock market index and exchange rate movement. The first type of factors will affect the return of almost all securities in the market. The risk or variation in return of a security is caused by two types of factors.
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