1. What is the Capital Asset Pricing Model (CAPM)?

The Capital Asset Pricing Model (CAPM) is a financial model that calculates the expected return of an asset based on its beta, the risk-free rate, and the expected market return. It describes the relationship between systematic risk and expected return for assets.

2. How Does the Calculator Work?

The calculator uses the CAPM formula:

Where:

• \( E(r) \) — Expected return of the investment
• \( R_f \) — Risk-free rate (typically government bond yield)
• \( \beta \) — Beta coefficient (measure of systematic risk)
• \( R_m \) — Expected return of the market
• \( (R_m - R_f) \) — Market risk premium

Explanation: The formula calculates the appropriate required rate of return of an asset, given that asset's non-diversifiable risk (beta), the risk-free rate, and the expected market return.

3. Importance of Expected Return Calculation

Details: CAPM is widely used in finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital. It helps investors make informed decisions about portfolio construction and risk management.

4. Using the Calculator

Tips: Enter the risk-free rate as a percentage (e.g., 2.5 for 2.5%), beta coefficient (typically between 0.5-2.0 for most stocks), and expected market return as a percentage. All values must be non-negative.

5. Frequently Asked Questions (FAQ)

Q1: What is considered a good beta value?
A: Beta measures volatility relative to the market. A beta of 1 indicates volatility equal to the market. Less than 1 means less volatile, more than 1 means more volatile. "Good" depends on risk tolerance.

Q2: How do I determine the risk-free rate?
A: Typically, the yield on government bonds (like 10-year Treasury notes) is used as the risk-free rate, as these are considered virtually risk-free investments.

Q3: What time period should I use for market return?
A: Historical average market returns are often used, typically ranging from 7-10% annually for the stock market, but this can vary by market and time period.

Q4: What are the limitations of CAPM?
A: CAPM assumes markets are efficient, investors are rational, and that beta is a complete measure of risk. It doesn't account for taxes, transaction costs, or that investors may have different borrowing and lending rates.

Q5: Can CAPM be used for any type of investment?
A: While primarily used for stocks, CAPM can be applied to any risky asset. However, it's most appropriate for publicly traded securities with established betas.