CAPM (Capital Asset Pricing Model) Calculator

The CAPM (Capital Asset Pricing Model) Calculator helps investors and financial analysts determine the expected return on a capital asset by considering the risk-free rate, the expected market return, and the beta of the security.

CAPM Formula

The expected return on a capital asset, E(Ri), is calculated using the following formula:

\[ E(Ri) = Rf + [ E(Rm) − Rf ] × βi \]

Where:

• E(Ri) is the expected return on the capital asset (%)
• Rf is the risk-free rate (%)
• E(Rm) is the expected return of the market (%)
• βi is the beta of the security

What is CAPM?

The Capital Asset Pricing Model (CAPM) is a financial tool used to assess the expected return on an investment, factoring in the risk of that investment compared to the market as a whole. It provides a systematic approach to calculate the required rate of return by incorporating the risk-free rate, the market risk premium, and the security's beta.

Example Calculation

To illustrate how CAPM works, consider the following example:

• Risk-Free Rate (Rf): 3%
• Expected Market Return (E(Rm)): 10%
• Beta (β): 4

Using the CAPM formula:

\[ E(Ri) = 3\% + \left(10\% - 3\%\right) \times 4 = 31\% \]

This result suggests a high expected return of 31%, primarily driven by the high beta value of 4, indicating a higher risk.

Importance of CAPM

CAPM is widely used in finance for estimating the expected return on risky assets, determining the cost of capital, and pricing securities. It allows investors to make informed decisions by balancing the potential return with the associated risk.

Common FAQs

1. What is Beta (β)?

   • Beta is a measure of a security's volatility in relation to the overall market. A beta greater than 1 indicates that the security is more volatile than the market.

2. Why is the Risk-Free Rate used in CAPM?

   • The Risk-Free Rate represents the return on an investment with zero risk, serving as the baseline for calculating the additional return required to compensate for risk.

3. How accurate is the CAPM model?

   • While CAPM is widely used, it has limitations. It assumes that investors are rational and markets are efficient, which may not always reflect real-world scenarios.

This calculator provides a straightforward way to apply CAPM, allowing users to evaluate the expected returns based on varying levels of risk and market conditions.