Financial Management: Principles and Applications, 13/e

8.3 The Security Market Line and the CAPM

In addition to implying that an investment’s beta is the appropriate measure of its risk, the Capital Asset Pricing Model (or the CAPM) describes how these betas relate to the expected rates of return that investors require on their investments. The key inσhts of the CAPM are that investments with the same beta have the same expected rate of return and that investors will require a higher rate of return on investments with higher betas.

To understand the CAPM expected return equation that comes from this theory, recall that the beta of a portfolio equals the average beta of the investments in the portfolio and that the expected return of a portfolio equals the average expected return of the investments ...