the Capital Asset Pricing Model (CAPM) says

CAPM formula: expected return = Rf + β(Rm - Rf)

The risk-free rate (Rf) represents the return on an investment with zero risk, typically government bonds. The market return (Rm) is the expected return of the overall market. By adding the risk premium (β(Rm - Rf)) to the risk-free rate, CAPM quantifies how much extra return an investor should demand for taking on additional risk.

Example

If the risk-free rate (Rf) is 2%, the expected market return (Rm) is 8%, and an asset has a beta (β) of 1.5, the expected return using CAPM would be: 2% + 1.5(8% - 2%) = 2% + 1.5(6%) = 2% + 9% = 11%.

Remember this

Understanding the CAPM formula is crucial for investors to make informed decisions about asset allocation and risk management in their portfolios.

Text adapted from Wikipedia, licensed under CC BY-SA 4.0.

Related concepts

Beta (finance)

Beta measures a stock's volatility relative to the market

Fama–French three-factor model

Fama-French model adds size and value factors to CAPM

Cronbach's alpha

Cronbach's alpha (α) measures internal consistency

Market capitalization

Market capitalization = share price × shares outstanding

Sharpe ratio

Sharpe ratio measures excess return per unit of risk: (R - Rf) / σ

Dividend discount model

D₁/(r - g) = stock price

Educational content, not financial advice.

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