Expected Return
Return on a risky asset expected in the future
Portfolio
Group of assets such as stocks and bonds held by an investor.
Portfolio weight
Percentage of a portfolio’s total value in a particular asset.
Systemic risk
A risk that influences a large number of assets. Also called market or nondiversifiable risk.
Unsystematic risk
A risk that affects at most a small number of assets. Also called unique, diversifiable, or asset-specific risk.
symbol for systematic unexpected risk
m
symbol for unsystematic unexpected risk
epsilon
Principle of diversification
Spreading an investment across a number of assets will eliminate some, but not all, of the risk.
Systematic risk principle
The expected return on a risky asset depends only on that asset’s systematic risk.
beta coefficient
Amount of systematic risk present in a particular risky asset relative to that in an average risky asset.
SML
Security Market Line. Positively sloped straight line displaying the relationship between expected return and beta
Market risk premium
Slope of the security market line; the difference between the expected return on a market portfolio and the risk-free rate.
CAPM
Capital Asset Pricing Model. Equation of the security market line showing the relationship between expected return and beta.
CAPM equation
E(Ri) = Rf + [E(RM) - Rf] x
βi
where: E(Ri) = expected return on asset i
Rf = Risk free return
E(RM) = Expected market return
βi = Beta for asset i
Market risk premium equation
[E(RM) - Rf]
alpha
The excess return an asset earns based on the level of risk taken.
Cost of capital
The minimum required return on a new investment.
