In CAPM, the term RM − RF is known as what?

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Multiple Choice

In CAPM, the term RM − RF is known as what?

Explanation:
RM − RF is the market risk premium—the extra return investors require for bearing the market’s non-diversifiable, systematic risk. In CAPM, the expected return on any asset is RF plus beta times the market risk premium: E[R_i] = RF + beta_i × (RM − RF). This premium captures the compensation for taking on exposure to the overall market; diversification can remove idiosyncratic risk, but systematic risk remains priced in. For example, if the market return is 8% and the risk-free rate is 3%, the market risk premium is 5%. An asset with beta 1 would have an expected return of 3% + 1×5% = 8%; with beta 0.5, it would be 3% + 0.5×5% = 5.5%. It’s not the beta itself, nor the risk-free rate, and it’s not WACC.

RM − RF is the market risk premium—the extra return investors require for bearing the market’s non-diversifiable, systematic risk. In CAPM, the expected return on any asset is RF plus beta times the market risk premium: E[R_i] = RF + beta_i × (RM − RF). This premium captures the compensation for taking on exposure to the overall market; diversification can remove idiosyncratic risk, but systematic risk remains priced in. For example, if the market return is 8% and the risk-free rate is 3%, the market risk premium is 5%. An asset with beta 1 would have an expected return of 3% + 1×5% = 8%; with beta 0.5, it would be 3% + 0.5×5% = 5.5%. It’s not the beta itself, nor the risk-free rate, and it’s not WACC.

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