The capital asset pricing theory is based on the premise that:
A) only unsystematic variability in cash flows is relevant.
B) only systematic variability in cash flows is relevant.
C) both systematic and unsystematic variability in cash flows are relevant.
D) neither systematic nor unsystematic variability in cash flows is relevant.

Question

Quizplus · Accepted Answer

The capital asset pricing theory states that only systematic variability in cash flows (or market risk) is relevant and can be priced in the market. Systematic risk is the risk that cannot be diversified away by holding a well-diversified portfolio. On the other hand, unsystematic variability in cash flows (or firm-specific risk) can be diversified away by holding a diversified portfolio of assets. Therefore, the CAPM only considers the systematic risk in determining the required rate of return on an asset.

The Capital Asset Pricing Theory Is Based on the Premise