the market portfolio. In other words, we can best measure the stocks contribution to the risk of the market portfolio by its covariance with that portfolio:   GMs contribution to variance wGMCov(rGM,rM)   This should not surprise us. For example, if the covariance between GM and the rest of the market is negative, then GM makes a "negative contribution" to portfolio risk: By pro- viding returns that move inversely with the rest of the market, GM stabilizes the return on the overall portfolio. If the covariance is positive, GM makes a positive contribution to overall portfolio risk because its returns amplify swings in the rest of the portfolio. To demonstrate this more rigorously, note that the rate of return on the market portfolio may be written as   n rM wkrk k 1 Therefore, the covariance of the return on GM with the market portfolio is   n n Cov(rGM, rM) Cov(rGM, wkrk) wkCov(rGM, rk) (9.4) k 1 k 1 Comparing the last term of equation 9.4 to the term in brackets in equation 9.3, we can see that the covariance of GM with the market portfolio is indeed proportional to the contribu- tion of GM to the variance of the market portfolio. Having measured the contribution of GM stock to market variance, we may determine the appropriate risk premium for GM. We note first that the market portfolio has a risk pre- mium of E(rM) rf and a variance of 2 , for a reward-to-risk ratio of E(rM) rf 2 (9.5) M   This ratio often is called the market price of risk,7 because it quantifies the extra return that investors demand to bear portfolio risk. The ratio of risk premium to variance tells us how much extra return must be earned per unit of portfolio risk. Consider an average investor who is currently invested 100% in the market portfolio and suppose he were to increase his position in the market portfolio by a tiny fraction, , financed by borrowing at the risk-free rate. Think of the new portfolio as a combination of three assets: the original position in the market with