Capital Asset Pricing Model
Capital Asset Pricing Model The Capital Asset Pricing Model (CAPM) entails the relationship between the expected return and the risk of investing in security. This model is used to analyze securities and price them given the expected rate of return and cost of capital involved. CAPM Formula The ( capital asset pricing model ) CAPM formula is represented below Expected Rate of Return = Risk-Free Premium + Beta * (Market Risk Premium) Ra = Rrf + βa * (Rm – Rrf ) Components of CAPM CAPM – cost of equity Risk Free Rate – The return investor expects from a completely risk-free investment Should be in the currency cash low Beta The degree to which a company’s equity returns varies with the return of the overall market. Beta is a function of both the business risk as well as the financial risk Beta is a measure of systematic risk Risk Premium I...