Sharpe ratio

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The Sharpe ratio or Sharpe index or Sharpe measure or reward-to-variability ratio is a

measure of the excess return (or risk premium) per unit of risk in an investment asset or a trading
strategy, named after William Forsyth Sharpe. Since its revision by the original author in 1994, it
is defined as:

where R is the asset return, Rf is the return on a benchmark asset, such as the risk free rate of
return, E[R − Rf] is the expected value of the excess of the asset return over the benchmark
return, and σ is the standard deviation of the excess of the asset return (this is often confused
with the excess return over the benchmark return; the Sharpe ratio utilizes the asset standard
deviation whereas the information ratio utilizes standard deviation of excess return over the
benchmark, i.e. the tracking error, as the denominator.). Note, if Rf is a constant risk free return
throughout the period,

The Sharpe ratio is used to characterize how well the return of an asset compensates the investor
for the risk taken, the higher the Sharpe ratio number the better. When comparing two assets
each with the expected return E[R] against the same benchmark with return Rf, the asset with
the higher Sharpe ratio gives more return for the same risk. Investors are often advised to pick
investments with high Sharpe ratios. However like any mathematical model it relies on the data
being correct. Pyramid schemes with a long duration of operation would typically provide a high
Sharpe ratio when derived from reported returns but the inputs are false. When examining the
investment performance of assets with smoothing of returns (such as with-profits funds) the
Sharpe ratio should be derived from the performance of the underlying assets rather than the
fund returns.

Sharpe ratios, along with Treynor ratios and Jensen's alphas, are often used to rank the
performance of portfolio or mutual fund managers.

From Wikipedia, the free encyclopedia

Jump to: navigation, search

The Treynor ratio (sometimes called the reward-to-volatility ratio or Treynor measure[1]),
named after Jack L. Treynor,[2] is a measurement of the returns earned in excess of that which
could have been earned on an investment that has no diversifiable risk (e.g., Treasury Bills or a
completely diversified portfolio), per each unit of market risk assumed.

The Treynor ratio relates excess return over the risk-free rate to the additional risk taken;
however, systematic risk is used instead of total risk. The higher the Treynor ratio, the better the
performance of the portfolio under analysis.

Contents
[hide]

 1 Formula
 2 Limitations
 3 See also
 4 References

[edit] Formula

where:

Treynor ratio,

portfolio i's return,

risk free rate

portfolio i's beta

What Does Treynor Ratio Mean?

A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been
earned on a riskless investment per each unit of market risk.  

The Treynor ratio is calculated as:

 
(Average Return of the Portfolio - Average Return of the Risk-Free Rate) /  Beta of the Portfolio

Investopedia explains Treynor Ratio

In other words, the Treynor ratio is a risk-adjusted measure of return based on systematic risk. It is similar
to the Sharpe ratio, with the difference being that the Treynor ratio uses beta as the measurement of
volatility.

Also known as the "reward-to-volatility ratio".

How to Calculate Treynor Ratio
By Nancy Z. Gleaton, eHow Contributor

Knowing how risky your investments are can help you manage them.

Treynor ratio, also called the Treynor index, is a measure of possible excess returns on investment if
more market risk is assumed. Another name, the reward-to-volatility ratio, is perhaps a more
meaningful term. The ratio was developed by Jack Treynor, the president of Treynor Capital
Management, Inc., in Palos Verdes Estates, California.

The formula for the Treynor Ratio is the difference of the average return of a portfolio and the
average return of a risk-free rate, divided by the beta of the portfolio or

(average portfolio return -- average return of risk-free rate) / portfolio beta

The beta of the portfolio is a measure of the volatility of a given investment measured against the
overall market. It usually measures the performance of the portfolio in the last five years as the
market index (usually the Standard & Poor's 500) moved up or down by 1 percent. A beta below a
value of one is less volatile.
Difficulty: Moderate

Instructions
Things You'll Need:

 Return rate of portfolio

 Risk-free rate of portfolio
 Beta of portfolio

1. 1
 Assume a portfolio return rate of 12 percent, a risk-free rate of 2 percent and a
portfolio beta of 1.2, and assign a variable to each number needed to do the
calculation:

Return rate of portfolio = A = 12

Risk-free rate = B = 2
Beta of portfolio = C = 1.2

2. 2

Substitute the numbers in the equation:

(A -- B) / C = (12 -- 2) / 1.2

3. 3

Solve the equation:

(12 -- 2) / 1.2 = 10 / 1.2 = 8.3 (rounded)

4. 4

Compare the ratio (index) against other portfolios.

A single Treynor ratio does not mean anything. It is used to compare the risk of
investments. The higher the ratio or index, the higher the risk.

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In finance, the capital asset pricing model (CAPM) is used to determine a theoretically
appropriate required rate of return of an asset, if that asset is to be added to an already well-
diversified portfolio, given that asset's non-diversifiable risk. The model takes into account the
asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk), often
represented by the quantity beta (β) in the financial industry, as well as the expected return of the
market and the expected return of a theoretical risk-free asset.

The model was introduced by Jack Treynor (1961, 1962),[1] William Sharpe (1964), John Lintner
(1965a,b) and Jan Mossin (1966) independently, building on the earlier work of Harry
Markowitz on diversification and modern portfolio theory. Sharpe, Markowitz and Merton
Miller jointly received the Nobel Memorial Prize in Economics for this contribution to the field
of financial economics.
 Contents
[hide]

 1 The formula
 2 Security market line
 3 Asset pricing
 4 Asset-specific required return
 5 Risk and diversification
 6 The efficient frontier
 7 The market portfolio
 8 Assumptions of CAPM
 9 Shortcomings of CAPM
 10 See also
 11 References
 12 Bibliography
 13 External links

[edit] The formula

The Security Market Line, seen here in a graph, describes a relation between the beta and the asset's
expected rate of return.

The CAPM is a model for pricing an individual security or a portfolio. For individual securities,
we make use of the security market line (SML) and its relation to expected return and systematic
risk (beta) to show how the market must price individual securities in relation to their security
risk class. The SML enables us to calculate the reward-to-risk ratio for any security in relation to
that of the overall market. Therefore, when the expected rate of return for any security is deflated
by its beta coefficient, the reward-to-risk ratio for any individual security in the market is equal
to the market reward-to-risk ratio, thus:
The market reward-to-risk ratio is effectively the market risk premium and by rearranging the
above equation and solving for E(Ri), we obtain the Capital Asset Pricing Model (CAPM).

where:

 is the expected return on the capital asset

 is the risk-free rate of interest such as interest arising from government bonds
 (the beta) is the sensitivity of the expected excess asset returns to the expected excess

market returns, or also ,

 is the expected return of the market
 is sometimes known as the market premium or risk premium (the difference
between the expected market rate of return and the risk-free rate of return).

Restated, in terms of risk premium, we find that:

which states that the individual risk premium equals the market premium times β.

Note 1: the expected market rate of return is usually estimated by measuring the Geometric
Average of the historical returns on a market portfolio (e.g. S&P 500).

Note 2: the risk free rate of return used for determining the risk premium is usually the arithmetic
average of historical risk free rates of return and not the current risk free rate of return.

For the full derivation see Modern portfolio theory.

[edit] Security market line

The SML essentially graphs the results from the capital asset pricing model (CAPM) formula.
The x-axis represents the risk (beta), and the y-axis represents the expected return. The market
risk premium is determined from the slope of the SML.

The relationship between β and required return is plotted on the securities market line (SML)
which shows expected return as a function of β. The intercept is the nominal risk-free rate
available for the market, while the slope is the market premium, E(Rm)− Rf. The securities market
line can be regarded as representing a single-factor model of the asset price, where Beta is
exposure to changes in value of the Market. The equation of the SML is thus:

It is a useful tool in determining if an asset being considered for a portfolio offers a reasonable
expected return for risk. Individual securities are plotted on the SML graph. If the security's
expected return versus risk is plotted above the SML, it is undervalued since the investor can
expect a greater return for the inherent risk. And a security plotted below the SML is overvalued
since the investor would be accepting less return for the amount of risk assumed.

[edit] Asset pricing

Once the expected/required rate of return, E(Ri), is calculated using CAPM, we can compare
this required rate of return to the asset's estimated rate of return over a specific investment
horizon to determine whether it would be an appropriate investment. To make this comparison,
you need an independent estimate of the return outlook for the security based on either
fundamental or technical analysis techniques, including P/E, M/B etc.

Assuming that the CAPM is correct, an asset is correctly priced when its estimated price is the
same as the present value of future cash flows of the asset, discounted at the rate suggested by
CAPM. If the observed price is higher than the CAPM valuation, then the asset is overvalued
(and undervalued when the estimated price is below the CAPM valuation).[citation needed] When the
asset does not lie on the SML, this could also suggest mis-pricing. Since the expected return of

the asset at time t is , a higher expected return than what CAPM

suggests indicates that Pt is too low (the asset is currently undervalued), assuming that at time t
+ 1 the asset returns to the CAPM suggested price.[2]

[edit] Asset-specific required return

The CAPM returns the asset-appropriate required return or discount rate—i.e. the rate at which
future cash flows produced by the asset should be discounted given that asset's relative riskiness.
Betas exceeding one signify more than average "riskiness"; betas below one indicate lower than
average. Thus, a more risky stock will have a higher beta and will be discounted at a higher rate;
less sensitive stocks will have lower betas and be discounted at a lower rate. Given the accepted
concave utility function, the CAPM is consistent with intuition—investors (should) require a
higher return for holding a more risky asset.

Since beta reflects asset-specific sensitivity to non-diversifiable, i.e. market risk, the market as a
whole, by definition, has a beta of one. Stock market indices are frequently used as local proxies
for the market—and in that case (by definition) have a beta of one. An investor in a large,
diversified portfolio (such as a mutual fund), therefore, expects performance in line with the
market.
[edit] Risk and diversification

The risk of a portfolio comprises systematic risk, also known as undiversifiable risk, and
unsystematic risk which is also known as idiosyncratic risk or diversifiable risk. Systematic risk
refers to the risk common to all securities—i.e. market risk. Unsystematic risk is the risk
associated with individual assets. Unsystematic risk can be diversified away to smaller levels by
including a greater number of assets in the portfolio (specific risks "average out"). The same is
not possible for systematic risk within one market. Depending on the market, a portfolio of
approximately 30-40 securities in developed markets such as UK or US will render the portfolio
sufficiently diversified such that risk exposure is limited to systematic risk only. In developing
markets a larger number is required, due to the higher asset volatilities.

A rational investor should not take on any diversifiable risk, as only non-diversifiable risks are
rewarded within the scope of this model. Therefore, the required return on an asset, that is, the
return that compensates for risk taken, must be linked to its riskiness in a portfolio context - i.e.
its contribution to overall portfolio riskiness - as opposed to its "stand alone riskiness." In the
CAPM context, portfolio risk is represented by higher variance i.e. less predictability. In other
words the beta of the portfolio is the defining factor in rewarding the systematic exposure taken
by an investor.

[edit] The efficient frontier

Main article: Efficient frontier

The (Markowitz) efficient frontier. CAL stands for the capital allocation line.

The CAPM assumes that the risk-return profile of a portfolio can be optimized—an optimal
portfolio displays the lowest possible level of risk for its level of return. Additionally, since each
additional asset introduced into a portfolio further diversifies the portfolio, the optimal portfolio
must comprise every asset, (assuming no trading costs) with each asset value-weighted to
achieve the above (assuming that any asset is infinitely divisible). All such optimal portfolios,
i.e., one for each level of return, comprise the efficient frontier.
Because the unsystematic risk is diversifiable, the total risk of a portfolio can be viewed as beta.

[edit] The market portfolio

An investor might choose to invest a proportion of his or her wealth in a portfolio of risky assets
with the remainder in cash—earning interest at the risk free rate (or indeed may borrow money to
fund his or her purchase of risky assets in which case there is a negative cash weighting). Here,
the ratio of risky assets to risk free asset does not determine overall return—this relationship is
clearly linear. It is thus possible to achieve a particular return in one of two ways:

1. By investing all of one's wealth in a risky portfolio,

2. or by investing a proportion in a risky portfolio and the remainder in cash (either borrowed or
invested).

For a given level of return, however, only one of these portfolios will be optimal (in the sense of
lowest risk). Since the risk free asset is, by definition, uncorrelated with any other asset, option 2
will generally have the lower variance and hence be the more efficient of the two.

This relationship also holds for portfolios along the efficient frontier: a higher return portfolio
plus cash is more efficient than a lower return portfolio alone for that lower level of return. For a
given risk free rate, there is only one optimal portfolio which can be combined with cash to
achieve the lowest level of risk for any possible return. This is the market portfolio.

[edit] Assumptions of CAPM

This section does not cite any references or sources.
Please help improve this article by adding citations to reliable sources. Unsourced material may be
challenged and removed. (July 2010)

All investors:

1. Aim to maximize economic utilities.

2. Are rational and risk-averse.
3. Are broadly diversified across a range of investments.
4. Are price takers, i.e., they cannot influence prices.
5. Can lend and borrow unlimited amounts under the risk free rate of interest.
6. Trade without transaction or taxation costs.
7. Deal with securities that are all highly divisible into small parcels.
8. Assume all information is available at the same time to all investors.

[edit] Shortcomings of CAPM

 The model assumes that either asset returns are (jointly) normally distributed random variables
or that investors employ a quadratic form of utility. It is however frequently observed that
returns in equity and other markets are not normally distributed. As a result, large swings (3 to 6
 standard deviations from the mean) occur in the market more frequently than the normal
distribution assumption would expect.[3]
 The model assumes that the variance of returns is an adequate measurement of risk. This might
be justified under the assumption of normally distributed returns, but for general return
distributions other risk measures (like coherent risk measures) will likely reflect the investors'
preferences more adequately. Indeed risk in financial investments is not variance in itself, rather
it is the probability of losing: it is asymmetric in nature.
 The model assumes that all investors have access to the same information and agree about the
risk and expected return of all assets (homogeneous expectations assumption). [citation needed]
 The model assumes that the probability beliefs of investors match the true distribution of
returns. A different possibility is that investors' expectations are biased, causing market prices to
be informationally inefficient. This possibility is studied in the field of behavioral finance, which
uses psychological assumptions to provide alternatives to the CAPM such as the overconfidence-
based asset pricing model of Kent Daniel, David Hirshleifer, and Avanidhar Subrahmanyam
(2001)[4].
 The model does not appear to adequately explain the variation in stock returns. Empirical
studies show that low beta stocks may offer higher returns than the model would predict. Some
data to this effect was presented as early as a 1969 conference in Buffalo, New York in a paper
by Fischer Black, Michael Jensen, and Myron Scholes. Either that fact is itself rational (which
saves the efficient-market hypothesis but makes CAPM wrong), or it is irrational (which saves
CAPM, but makes the EMH wrong – indeed, this possibility makes volatility arbitrage a strategy
for reliably beating the market).[citation needed]
 The model assumes that given a certain expected return investors will prefer lower risk (lower
variance) to higher risk and conversely given a certain level of risk will prefer higher returns to
lower ones. It does not allow for investors who will accept lower returns for higher risk. Casino
gamblers clearly pay for risk, and it is possible that some stock traders will pay for risk as well.
[citation needed]

 The model assumes that there are no taxes or transaction costs, although this assumption may
be relaxed with more complicated versions of the model. [citation needed]
 The market portfolio consists of all assets in all markets, where each asset is weighted by its
market capitalization. This assumes no preference between markets and assets for individual
investors, and that investors choose assets solely as a function of their risk-return profile. It also
assumes that all assets are infinitely divisible as to the amount which may be held or transacted.
[citation needed]

 The market portfolio should in theory include all types of assets that are held by anyone as an
investment (including works of art, real estate, human capital...) In practice, such a market
portfolio is unobservable and people usually substitute a stock index as a proxy for the true
market portfolio. Unfortunately, it has been shown that this substitution is not innocuous and
can lead to false inferences as to the validity of the CAPM, and it has been said that due to the
inobservability of the true market portfolio, the CAPM might not be empirically testable. This
was presented in greater depth in a paper by Richard Roll in 1977, and is generally referred to as
Roll's critique.[5]
 The model assumes just two dates, so that there is no opportunity to consume and rebalance
portfolios repeatedly over time. The basic insights of the model are extended and generalized in
the intertemporal CAPM (ICAPM) of Robert Merton, and the consumption CAPM (CCAPM) of
Douglas Breeden and Mark Rubinstein. [citation needed]
 CAPM assumes that all investors will consider all of their assets and optimize one portfolio. This
is in sharp contradiction with portfolios that are held by individual investors: humans tend to
 have fragmented portfolios or, rather, multiple portfolios: for each goal one portfolio — see
behavioral portfolio theory [6] and Maslowian Portfolio Theory [7].

Capital Asset Pricing Model - CAPM

What Does Capital Asset Pricing Model - CAPM Mean?

A model that describes the relationship between risk and expected return and that is used in the pricing of
risky securities.

The general idea behind CAPM is that investors need to be compensated in two ways: time value of
money and risk. The time value of money is represented by the risk-free (rf) rate in the formula and
compensates the investors for placing money in any investment over a period of time. The other half of
the formula represents risk and calculates the amount of compensation the investor needs for taking
on additional risk. This is calculated by taking a risk measure (beta) that compares the returns of the
asset to the market over a period of time and to the market premium (Rm-rf).

The Capital Asset Pricing Model: An

Overview
by Ben McClure (Contact Author | Biography)

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Filed Under: Economics, Financial Theory

No matter how much we diversify our investments, it's impossible to get rid of all the risk. As
investors, we deserve a rate of return that compensates us for taking on risk. The capital asset
pricing model (CAPM) helps us to calculate investment risk and what return on investment we
should expect. Here we look at the formula behind the model, the evidence for and against the
accuracy of CAPM, and what CAPM means to the average investor.

Birth of a Model
The capital asset pricing model was the work of financial economist (and, later, Nobel laureate in
economics) William Sharpe, set out in his 1970 book "Portfolio Theory And Capital Markets." His model
starts with the idea that individual investment contains two types of risk:

1. Systematic Risk - These are market risks that cannot be diversified away. Interest rates,
recessions and wars are examples of systematic risks.

2. Unsystematic Risk - Also known as "specific risk," this risk is specific to individual stocks and can
be diversified away as the investor increases the number of stocks in his or her portfolio. In more
technical terms, it represents the component of a stock's return that is not correlated with general
market moves.

Modern portfolio theory shows that specific risk can be removed through diversification. The
trouble is that diversification still doesn't solve the problem of systematic risk; even a portfolio of
all the shares in the stock market can't eliminate that risk. Therefore, when calculating a deserved
return, systematic risk is what plagues investors most. CAPM, therefore, evolved as a way to
measure this systematic risk. (To learn more, see Modern Portfolio Theory: An Overview.)

The Formula
Sharpe found that the return on an individual stock, or a portfolio of stocks, should equal its cost
of capital. The standard formula remains the CAPM, which describes the relationship between
risk and expected return.

Here is the formula:

CAPM's starting point is the risk-free rate - typically a 10-year government bond yield. To this is added a
premium that equity investors demand to compensate them for the extra risk they accept. This equity
market premium consists of the expected return from the market as a whole less the risk-free rate of
return. The equity risk premium is multiplied by a coefficient that Sharpe called "beta."

Beta
According to CAPM, beta is the only relevant measure of a stock's risk. It measures a stock's relative
volatility - that is, it shows how much the price of a particular stock jumps up and down compared with
how much the stock market as a whole jumps up and down. If a share price moves exactly in line with the
market, then the stock's beta is 1. A stock with a beta of 1.5 would rise by 15% if the market rose by 10%,
and fall by 15% if the market fell by 10%. (For further reading, see Beta: Gauging Price Fluctuations and
Beta: Know The Risk.)

Beta is found by statistical analysis of individual, daily share price returns, in comparison with the market's
daily returns over precisely the same period. In their classic 1972 study titled "The Capital Asset Pricing
Model: Some Empirical Tests," financial economists Fischer Black, Michael C. Jensen and Myron
Scholes confirmed a linear relationship between the financial returns of stock portfolios and their betas.
They studied the price movements of the stocks on the New York Stock Exchange between 1931 and
1965.

Beta, compared with the equity risk premium, shows the amount of compensation equity investors need
for taking on additional risk. If the stock's beta is 2.0, the risk-free rate is 3% and the market rate of return
is 7%, the market's excess return is 4% (7% - 3%). Accordingly, the stock's excess return is 8% (2 X 4%,
multiplying market return by the beta), and the stock's total required return is 11% (8% + 3%, the stock's
excess return plus the risk-free rate).

What this shows is that a riskier investment should earn a premium over the risk-free rate - the amount
over the risk-free rate is calculated by the equity market premium multiplied by its beta. In other words, it's
possible, by knowing the individual parts of the CAPM, to gauge whether or not the current price of a
stock is consistent with its likely return - that is, whether or not the investment is a bargain or too
expensive.

What CAPM Means for You

This model presents a very simple theory that delivers a simple result. The theory says that the only
reason an investor should earn more, on average, by investing in one stock rather than another is that
one stock is riskier. Not surprisingly, the model has come to dominate modern financial theory. But does it
really work?

It's not entirely clear. The big sticking point is beta. When professors Eugene Fama and Kenneth French
looked at share returns on the New York Stock Exchange, the American Stock Exchange and Nasdaq
between 1963 and 1990, they found that differences in betas over that lengthy period did not explain the
performance of different stocks. The linear relationship between beta and individual stock returns also
breaks down over shorter periods of time. These findings seem to suggest that CAPM may be wrong.

While some studies raise doubts about CAPM's validity, the model is still widely used in the investment
community. Although it is difficult to predict from beta how individual stocks might react to particular
movements, investors can probably safely deduce that a portfolio of high-beta stocks will move more than
the market in either direction, and a portfolio of low-beta stocks will move less than the market.

This is important for investors - especially fund managers - because they may be unwilling to or prevented
from holding cash if they feel that the market is likely to fall. If so, they can hold low-beta stocks instead.
Investors can tailor a portfolio to their specific risk-return requirements, aiming to hold securities with
betas in excess of 1 while the market is rising, and securities with betas of less than 1 when the market is
falling.

Not surprisingly, CAPM contributed to the rise in use of indexing - assembling a portfolio of shares to
mimic a particular market - by risk averse investors. This is largely due to CAPM's message that it is only
possible to earn higher returns than those of the market as a whole by taking on higher risk (beta). (To
learn more, see The Lowdown On Index Funds.)

Conclusion
The capital asset pricing model is by no means a perfect theory. But the spirit of CAPM is correct. It
provides a usable measure of risk that helps investors determine what return they deserve for putting their
money at risk. To learn more, see Achieving Better Returns In Your Portfolio.

by Ben McClure (Contact Author | Biography)

Ben McClure is a long-time contributor to Investopedia.com.

Ben is the director of Bay of Thermi Limited, an independent research and consulting firm that
specializes in preparing early stage ventures for new investment and the marketplace. He works
with a wide range of clients in the North America, Europe and Latin America. Ben was a highly-
rated European equities analyst at London-based Old Mutual Securities, and led new venture
development at a major technology commercialization consulting group in Canada. He started
his career as writer/analyst at the Economist Group. Mr. McClure graduated from the
University of Alberta's School of Business with an MBA.

Ben's hard and fast investing philosophy is that the herd is always wrong, but heck, if it pays,
there's nothing wrong with being a sheep.

He lives in Thessaloniki, Greece. You can learn more about Bay of Thermi Limited at
www.bayofthermi.com.

Filed Under: Economics, Financial Theory

What Does Security Market Line - SML Mean?

A line that graphs the systematic, or market, risk versus return of the whole market at a certain time and
shows all risky marketable securities.

Also refered to as the "characteristic line".

Investopedia explains Security Market Line - SML

The SML essentially graphs the results from the capital asset pricing model (CAPM) formula. The x-axis
represents the risk (beta), and the y-axis represents the expected return. The market risk premium is
determined from the slope of the SML. 

The security market line is a useful tool in determining whether an asset being considered for a portfolio
offers a reasonable expected return for risk. Individual securities are plotted on the SML graph. If the
security's risk versus expected return is plotted above the SML, it is undervalued because the investor
can expect a greater return for the inherent risk. A security plotted below the SML is overvalued because
the investor would be accepting less return for the amount of risk assumed.

The Security Market Line

The formula for CAPM is Ks = Krf + B ( Km - Krf).

Let's assume that the risk free rate is 5%, and the overall stock market will produce a rate of
return of 12.5% next year. You see that XYZ company (Read our disclaimer) has a beta of 1.7

I f you make a graph of this situation, it would look like this:

 On the horizontal axis are the betas of all companies in the market
 On the vertical axis are the required rates of return, as a percentage

The red line is the Security Market Line.

How did we get it? We plugged in a few sample betas into the equation
Ks = Krf + B ( Km - Krf).

Security Beta (measures risk) Rate of Return

'Risk Free' 0.0 5.00%
Overall Stock Market 1.0 12.50%
XYZ Company 1.7 17.75%