What is CAPM & how does it work?

It is a finance model that establishes a linear relationship between the required return on an investment and risk. CAPM is based on the relationship between an asset’s beta, the risk-free rate (typically the Treasury bill rate), and the equity risk premium, or the expected return on the market minus the risk-free rate.

What does CAPM stand for?

CAPM stand for “Capital Asset Pricing Model” and is a common valuation method for stocks. What is CAPM? The Capital Asset Pricing Model, or CAPM, calculates the value of a security based on the expected return relative to the risk investors incur by investing in that security. How is CAPM calculated?

How is CAPM calculated?

CAPM is calculated according to the following formula: Where: Note: “Risk Premium” = (Rm – Rrf) The CAPM formula is used for calculating the expected returns of an asset. It is based on the idea of systematic risk (otherwise known as non-diversifiable risk) that investors need to be compensated for in the form of a risk premium.