CAPM Lecture Notes

These flashcards cover key vocabulary terms and concepts related to the Capital Asset Pricing Model (CAPM) and its implications in finance.

Capital Asset Pricing Model (CAPM)

An equilibrium asset pricing model that describes the relationship between systematic risk and expected return.

Efficient Frontier

A graphical representation of the risk-return trade-off in an investment portfolio where assets are optimally allocated.

Systematic Risk

Risk inherent to the entire market or market segment, also known as market risk.

Nonsystematic Risk

Risk that is specific to a single asset or a small group of assets, also known as idiosyncratic risk.

Sharpe Ratio

A measure that indicates the average return minus the risk-free return per unit of volatility or total risk.

Market Portfolio

A theoretical portfolio that includes all risky assets held in proportion to their market value.

Beta (β)

A measure of a stock's volatility in relation to the overall market, indicating the systematic risk of an asset.

Security Market Line (SML)

A graphical representation of the CAPM that shows the expected return of assets as a function of their beta.

Alpha (α)

A measure of an investment's performance on a risk-adjusted basis, often used to assess active management.

Risk-free Rate (rf)

The theoretical rate of return on an investment with zero risk, often represented by government bonds.

Market Risk Premium

The additional return expected from holding a risky market portfolio over the risk-free rate.

Covariance

A statistical measure of how two variables change together, used in calculating risk.

Correlation (ρ)

A measure of the degree to which two assets move in relation to each other, ranging from -1 to 1.

Idiosyncratic Risk

Risk that can be eliminated through diversification, not compensated in the CAPM.

Mean-Variance Optimization

An investment strategy aiming to maximize expected return for a given level of risk.