Capital asset pricing model (CAPM)
Capital asset pricing model, or CAPM, is a financial model used to determine the expected return on an investment based on its risk level. The model takes into account the risk-free rate of return, the expected market return, and the beta of the investment.
The formula for CAPM is as follows:
Expected Return = Risk-Free Rate + Beta * (Market Return – Risk-Free Rate)
For example, if the risk-free rate is 3%, the expected market return is 8%, and the beta of the investment is 1.2, the expected return on the investment would be:
Expected Return = 3% + 1.2 * (8% – 3%) = 3% + 1.2 * 5% = 3% + 6% = 9%
The CAPM model is widely used in finance to help investors assess the risk and return of different investments and make informed decisions about their portfolios.