Capital Asset Pricing Model (CAPM) Calculator

The Capital Asset Pricing Model (CAPM) Explained

The Capital Asset Pricing Model (CAPM) is a financial equation used to find the expected return on an investment based on its risk compared to the broader market. It quantifies the relationship between risk and return which aids investors in making informed decisions.

How CAPM Works

The CAPM model is based on the premise that investors need to be compensated for the time value of money and risk they assume. The formula is as follows:

Expected Return = Risk-Free Rate + Beta × (Market Return – Risk-Free Rate)

Key Components of CAPM

• Risk-Free Rate: A theoretical rate of return of an investment with zero risk, often illustrated by government bonds.
• BetaA measure of the stockVolatility in relation to the market. Higher risk, higher potential return: beta > 1
• Market Return: The rate of return expected from the market, often based on historical data.

Using the CAPM formula, the expected return would be:

Expected Return = 2% + 1.5 × (8% – 2%) = 2% + 1.5 × 6% = 2% + 9% = 11%

Interesting Facts About CAPM

• The Capital Asset Pricing Model (CAPM) was pioneered in the 60s by economists William Sharpe, John Lintner and Jan Mossin.
• In finance, it is extensively used in making decisions like capital budgeting and portfolio management.
• CAPM relies on the assumptions of rational behavior and market efficiency, which sometimes do not align.
• It gives you a standard against which to measure an investment.

CAPM Calculator Examples