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CAPM Formula:
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The Capital Asset Pricing Model (CAPM) calculates the expected return on an investment based on its systematic risk (beta), the risk-free rate, and the expected market return. It helps investors determine the appropriate required rate of return for an asset given its risk level.
The calculator uses the CAPM formula:
Where:
Explanation: The formula calculates the expected return by adding the risk-free rate to the product of beta and the market risk premium (Rm - Rf).
Details: CAPM is widely used in finance for portfolio management, capital budgeting, and security valuation. It helps investors assess whether an investment offers a reasonable expected return for its level of risk.
Tips: Enter the risk-free rate (typically government bond yield), beta coefficient (available from financial databases), and expected market return. All values must be non-negative percentages.
Q1: What is considered a good expected return?
A: A good expected return depends on the investment's risk level. Higher beta stocks should have higher expected returns to compensate for greater risk.
Q2: How do I determine the risk-free rate?
A: Typically, the yield on 10-year government bonds is used as the risk-free rate for long-term investments.
Q3: What does beta represent?
A: Beta measures a stock's volatility relative to the overall market. A beta of 1 means the stock moves with the market, while beta >1 indicates higher volatility.
Q4: Are there limitations to CAPM?
A: Yes, CAPM assumes efficient markets, rational investors, and that beta remains constant over time, which may not always hold true in real markets.
Q5: Can CAPM be used for all types of investments?
A: CAPM is most appropriate for publicly traded stocks. It may be less suitable for private companies, real estate, or other alternative investments.