The capital asset pricing model approach to equity valuation:
A) is dependent upon the unsystematic risk of a security.
B) assumes the reward-to-risk ratio increases as beta increases.
C) can only be applied to dividend-paying firms.
D) assumes a firm's future risks will be higher than its current risks.
E) assumes the reward-to-risk ratio is constant.

Question

Quizplus · Accepted Answer

The capital asset pricing model approach assumes the reward-to-risk ratio is constant, meaning that an investor should be compensated with a higher return for taking on higher systematic risk (measured by beta) but not for unsystematic risk (which can be diversified away). The model does not require a firm to pay a dividend and does not assume future risks will be higher than current risks.

The Capital Asset Pricing Model Approach to Equity Valuation