The correlation between a company's gross revenue and the...

The correlation between a company's gross revenue and the market index is 0.2 . The excess return of the market over the risk-free rate is $6 \%$ and the volatility of the market index is $18 \%$. What is the market price of risk for the company's revenue?

Key Concepts

Market Price of Risk

The market price of risk, often expressed as a Sharpe ratio, is defined as the excess return per unit of risk. It quantifies how much additional return is required by investors to compensate for taking on an extra unit of risk, thus providing a bridge between risk and expected return in asset pricing.

Correlation

Correlation is a statistical measure that quantifies the degree to which two variables move in tandem. In finance, the correlation between an asset’s returns and the market’s returns indicates how strongly the asset co-moves with overall market fluctuations, which is crucial for assessing systematic risk.

Volatility

Volatility represents the degree of variation in the price of an asset over time, typically measured by the standard deviation of its returns. It serves as a key indicator of risk, with higher volatility reflecting greater uncertainty in the asset's performance.

Beta

Beta is a metric used to measure an asset’s sensitivity to market movements. It is calculated by scaling the correlation between the asset and the market by the ratio of their volatilities. Beta plays a central role in models like the CAPM, as it links an asset’s risk with the expected excess return.

Capital Asset Pricing Model (CAPM)

The Capital Asset Pricing Model is a foundational financial model that establishes a linear relationship between the expected return of an asset and its systematic, non-diversifiable risk (measured by beta). CAPM is extensively used in finance to estimate the appropriate required rate of return given the asset's market risk exposure.

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