1. What is the CAPM?

The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks. It is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital.

2. How Does the Calculator Work?

The calculator uses the CAPM formula:

Where:

• \( E(r) \) — Expected return on the capital asset
• \( Rf \) — Risk-free rate (%)
• \( \beta \) — Beta of the security (unitless)
• \( Rm \) — Expected return of the market (%)

Explanation: The CAPM formula shows that the expected return on a security equals the risk-free return plus a risk premium based on the security's beta.

3. Importance of CAPM Calculation

Details: CAPM is crucial for determining the required rate of return for risky assets, evaluating investment opportunities, portfolio management, and corporate finance decisions.

4. Using the Calculator

Tips: Enter risk-free rate in %, beta coefficient (unitless), and expected market return in %. All values must be valid non-negative numbers.

5. Frequently Asked Questions (FAQ)

Q1: What is considered a risk-free rate?
A: Typically, government bond yields (like US Treasury bonds) are used as risk-free rates since they have virtually no default risk.

Q2: How is beta calculated?
A: Beta is calculated using regression analysis of a stock's returns against market returns. A beta of 1 indicates the stock moves with the market.

Q3: What are typical market return expectations?
A: Historical market returns average around 7-10% annually, but this varies 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 the only measure of risk, which may not always hold true.

Q5: How is CAPM used in practice?
A: CAPM is used for determining cost of equity, evaluating stock performance, portfolio construction, and capital budgeting decisions.