CAPM Calculator - Capital Asset Pricing Model
Calculate expected returns using the Capital Asset Pricing Model (CAPM). This model determines the expected return of an asset based on its beta and the market risk premium.
CAPM Parameters
CAPM Results
Expected Return:
0.00%
Market Risk Premium:
Risk-Adjusted Return:
0.00%
Investment Analysis
Fair Value Assessment:
N/A
Risk Level:
N/A
Investment Decision:
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Business Insights
Cost of Equity:
0.00%
Required Return:
0.00%
Valuation Impact:
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Understanding the Capital Asset Pricing Model (CAPM)
The Capital Asset Pricing Model (CAPM) is a fundamental concept in finance that describes the relationship between systematic risk and expected return for assets. It provides a framework for pricing risky securities and calculating the cost of equity capital.
CAPM Formula and Components
The CAPM Formula
- Expected Return = Risk-Free Rate + Beta × (Market Return - Risk-Free Rate)
- Expected Return = Rf + ß × (Rm - Rf)
- Where Rf = Risk-free rate, ß = Beta, Rm = Market return
- Market risk premium = Rm - Rf
Key Components
- Risk-Free Rate: Return on risk-free investments (e.g., government bonds)
- Beta: Measure of systematic risk relative to market
- Market Return: Expected return of the market portfolio
- Risk Premium: Additional return required for market risk
CAPM Assumptions
Model Assumptions
Foundation of the CAPM theory
Market Assumptions
- Investors are rational and risk-averse
- Perfect capital markets with no transaction costs
- All investors have access to same information
- Investors can borrow and lend at risk-free rate
Asset Assumptions
- All assets are infinitely divisible
- No taxes or inflation
- Investors have homogeneous expectations
- Single-period investment horizon
Interpreting CAPM Results
Expected Return Analysis
- Minimum required return for given risk level
- Basis for investment decision making
- Used in portfolio construction
- Foundation for modern portfolio theory
Risk-Return Relationship
- Higher beta requires higher expected return
- Linear relationship between risk and return
- Systematic risk is rewarded in market
- Unsystematic risk can be diversified away
CAPM Applications
| Application | Purpose | Benefits | Limitations |
|---|---|---|---|
| Cost of Equity | Calculate required return on equity | Used in DCF valuation | Assumes market efficiency |
| Portfolio Management | Asset allocation decisions | Risk-return optimization | Historical beta may change |
| Performance Evaluation | Assess investment performance | Benchmark against required return | Does not account for unsystematic risk |
| Capital Budgeting | Project evaluation | Risk-adjusted discount rates | Beta estimation challenges |
CAPM Limitations and Criticisms
Theoretical Limitations
- Unrealistic assumptions about markets
- Single-factor model ignores other risks
- Assumes investors are perfectly rational
- Static model in dynamic markets
Practical Challenges
- Beta estimation errors
- Changing beta over time
- Market portfolio proxy issues
- Risk-free rate selection
Alternative Models
Multi-Factor Models
- Fama-French Three-Factor Model
- Carhart Four-Factor Model
- Arbitrage Pricing Theory (APT)
- Consider multiple risk factors
Behavioral Models
- Prospect Theory
- Behavioral CAPM
- Incorporate investor psychology
- Account for market anomalies
Key Takeaways for CAPM
- CAPM calculates expected return as: Rf + ß × (Rm - Rf)
- The model assumes investors are rational and markets are efficient
- Beta measures systematic risk that cannot be diversified away
- Higher beta stocks require higher expected returns
- CAPM is widely used for cost of equity calculations in valuation
- The model has limitations but remains a cornerstone of modern finance
- Alternative models exist for more complex risk-return relationships
- CAPM provides a theoretical foundation for portfolio management