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Risk & Reward In A Stock Portfolio Using A CAPM Approach.

The general idea behind CAPM is that investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk measure (βa) that compares the returns of the asset to the market over a period of time and to the market premium (r̅m - rf). The CAPM still remains popular due to its simplicity and utility in a variety of situations. It has been said that a portfolio's Beta is the reason for 70% of its actual stock returns.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.