According to the Capital Asset Pricing Model, a stock's risk premium is the:
A)price premium on low risk stocks that investors buy for safety.
B)risk premium on an average stock factored by a measure of the stock's market risk.
C)risk premium on an average stock factored by a measure of the stock's total risk.
D)extra money paid for high risk stocks because of their high average returns.

Question

Quizplus · Accepted Answer

The Capital Asset Pricing Model (CAPM) defines a stock's risk premium as the excess return above the risk-free rate that investors require to compensate for the extra risk they are taking by investing in that stock. This excess return is calculated by multiplying the stock's beta (i.e., a measure of the stock's market risk) by the market risk premium (i.e., the return of the overall market minus the risk-free rate). Therefore, choice B is the correct answer as it refers to the risk premium of an average stock factored by a measure of the stock's market risk, which is consistent with the CAPM.

According to the Capital Asset Pricing Model, a Stock's Risk