Published Feb 4, 2023 CAPM is a finance model that outlines the connection between the expected return on assets, especially stocks, and systematic risk, which is the general hazard involved in investing. The model creates a linear association between the risk and the required return on investment. It takes into account the beta of an asset, the risk-free rate (often represented by the Treasury bill rate), and the equity risk premium, which is the difference between the expected return on the market and the risk-free rate. Let’s consider a scenario where an investor is evaluating a stock with a present value of $120 per share, paying a 4% annual dividend. The stock has a beta of 1.5 in comparison to the market, implying that it is more unpredictable than a broad market index. Also, assume that the risk-free rate is 4%, and the investor anticipates the market to grow by 9% annually. In that case, the expected return based on CAPM is 10% (i.e., 4% + 1.5*[8% – 4%]). The CAPM is an important tool for investors, as it helps them to determine the expected return of an asset. By taking into account the risk of an asset and the expected return of the overall market, the CAPM provides investors with a way to compare different investments and decide which one is the most suitable for their needs. In addition, the CAPM is also used by financial analysts to value stocks and other assets.Definition of Capital Asset Pricing Model (CAPM)
Example
Why CAPM Matters
Business Economics