Investors are risk-averse and must be compensated for taking risk. Thus,risky securities are priced by the market to yield a higher expected return low-risk securities. This extra reward,called the risk premium,is necessary to induce risk-averse investors tohold risky securities. In a market dominated by risk-averse investors, there must be a positive relation between risk and expected return to achieve equilibrium. The expected return on a risk-free security (such as a Treasury bill) is the risk-free rate.The expected return on risky securities can be thought of as this risk-free rate plus a premium for risk:
Rs=Rf+Risk premium
the market's risk/return trade-off is illustrated in Figure 3