Home
Back
CAPM Formula:
| From: | To: |
The CAPM (Capital Asset Pricing Model) calculates the expected return on an investment based on its systematic risk (beta), the risk-free rate, and the expected market return. It provides a theoretical estimate of the appropriate required rate of return for an asset given its risk level.
The calculator uses the CAPM formula:
Where:
Explanation: The model quantifies the relationship between systematic risk and expected return, suggesting that investors should be compensated for time value of money and risk.
Details: CAPM is widely used in finance for portfolio management, capital budgeting, and valuation. It helps determine whether an investment offers a reasonable expected return for its risk level and is fundamental to modern portfolio theory.
Tips: Enter risk-free rate as a percentage (typically government bond yield), beta coefficient (available from financial databases), and expected market return. All values must be valid numerical inputs.
Q1: What is the risk-free rate typically based on?
A: The risk-free rate is usually based on government bond yields, such as 10-year US Treasury bonds for US investments.
Q2: How is beta coefficient determined?
A: Beta is calculated by regressing the asset's returns against market returns. A beta of 1 indicates movement with the market, >1 indicates higher volatility, and <1 indicates lower volatility.
Q3: What are typical market risk premium values?
A: Historical market risk premiums typically range from 4-6%, though this varies by market and time period.
Q4: What are the main limitations of CAPM?
A: CAPM assumes efficient markets, rational investors, and that beta fully captures risk. It may not account for other risk factors that affect returns.
Q5: How is CAPM used in practice?
A: CAPM is used to determine cost of equity, evaluate investment opportunities, assess portfolio performance, and set required rates of return for capital projects.