Question

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.A) TrueB) False

Answer 1

Answer:

A) True

Explanation:

The purpose of creating a portfolio is to diversify investment and achieve risk reduction as famously conveyed by the proverb, "do not put all the eggs in a single basket".

The Capital Asset Pricing Model (CAPM) was developed by William Sharpe and John Lintner. The model explains the relationship between expected return of an investor and the investment risk.

Return earned by a portfolio is the weighted average return of the individual stock returns.

CAPM helps calculate expected return of an investor by the following formula:

$Return = R_{f} \ + B(R_{m}\ -\ R_{f} )$

wherein, $R_{f} =$ Risk free rate of return yielded by treasury bonds

              B = Beta, which is a coefficient which conveys the degree of responsiveness of security return in relation to the market return.

             $R_{m}=$ Return which can be earned on market portfolio

Thus, the relevant risk with respect to a portfolio refers to an individual stock's share of contribution to the portfolio risk.