Market portfolio
In CAPM, the market portfolio is the reference against which systematic risk and beta are defined. Its expected return, together with the risk-free rate, determines the market risk premium used in the model. The theoretical portfolio is not directly observable in full, so a broad market index is often used as an imperfect proxy. A portfolio's beta and market weights depend on the specified benchmark and period. A broad index is not automatically identical to the theoretical market portfolio or proof that an individual investor is fully diversified.
Worked example
If a CAPM question states an expected market return of 9% and risk-free rate of 3%, its market risk premium is 6 percentage points. An equity beta of 1.2 gives the required return after adding the risk-free rate: 3% + 1.2 × 6% = 10.2%.
Common mistake
Treating an index as a perfect measure of every risky asset or omitting the risk-free component when using the market premium.
Where it appears in your exams
| Qualification | Exam | Relationship | Period |
|---|---|---|---|
| ACCA | AFM | Supporting | September 2026–June 2027 |
| ACCA | FM | Supporting | September 2026–June 2027 |