What does a beta of zero indicate about the expected return on a risky asset according to CAPM?

A beta of zero signifies that the asset has no correlation with market movements. In the Capital Asset Pricing Model (CAPM), beta is a measure of an asset's systematic risk relative to the market. Since a beta of zero indicates that the asset's price movements are entirely independent of market trends, the expected return on such an asset is exclusively derived from its risk-free component.

Under the CAPM framework, the expected return on any risky asset is determined by the risk-free rate plus a risk premium based on its beta. For an asset with a beta of zero, the risk is non-existent in relation to market changes, which means there is no risk premium to add to the risk-free rate. Therefore, the return for this asset would be equivalent to the risk-free rate, as there is no expectation for higher returns associated with any additional risk.

This understanding aligns with the fundamental principles of finance, which assert that returns should compensate investors for the level of risk they undertake. A beta of zero means the asset is risk-free in relation to market risk, leading to the conclusion that the expected return must match the risk-free rate.