Systematic Risk

Systematic risk is the risk that affects the whole market, such as recessions, interest rate changes and inflation. Diversification cannot remove it. CAPM says investors are paid only for this risk, and beta measures how much of it a stock carries.

A stock with a beta of 1.2 carries more systematic risk than the market, so it gets a larger premium: 1.2 x 5% = 6% over the risk-free rate, for an 11% cost of equity. Risk unique to one company, called unsystematic or specific risk, earns nothing extra in CAPM because investors can hold many stocks.

Private company valuations often add some of that specific risk back through a company-specific risk premium. See beta, the capital asset pricing model, and whether cost of equity increases with debt for how borrowing adds to it.