If the rate of return on the stock market is r_m and the rate of return on a risk-free asset is r_f, then:

A) r_m - r_f measures the risk, all of it nondiversifiable, one has to accept in the stock market.
B) r_m - r_f measures the risk, all of it diversifiable, one has to accept in the stock market.
C) r_m + r_f measures the risk, all of it nondiversifiable, one has to accept in the stock market.
D) r_m + r_f measures the risk, all of it diversifiable, one has to accept in the stock market.
E) r_m + r_f measures the stock market's total risk.

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Jamal Tavosi · Accepted Answer

Final Answer : A, Explanation :  The difference between the rate of return on the stock market and the risk-free rate of return represents the additional return an investor can earn by taking on the risk of investing in the stock market. This risk includes both diversifiable (company-specific) and non-diversifiable (market-wide) components, but since the question specifies all of it nondiversifiable, we can conclude that the difference in returns measures the non-diversifiable risk an investor must accept in order to earn the higher return from the stock market.

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