The capital asset pricing model (CAPM) is an idealized portrayal of how financial markets price securities and thereby determine expected returns on capital investments. The model provides a methodology for quantifying risk and translating that risk into estimates of expected return on equity.
What does CAPM model tell us?
The capital asset pricing model - or CAPM - is a financial model that calculates the expected rate of return for an asset or investment. CAPM does this by using the expected return on both the market and a risk-free asset, and the asset's correlation or sensitivity to the market (beta).
What are the 4 components of the Capital Asset Pricing Model CAPM equation?
CAPM states that Investors make investment decisions based on risk and return. The return and risk are calculated by the variance and the mean of the portfolio. CAPM reinstates that rational investors discard their diversifiable risks or unsystematic risks.
What is CAPM model and its assumptions?
In layman's terms, the CAPM formula is: Expected return of the investment = the risk-free rate + the beta (or risk) of the investment * the expected return on the market – the risk free rate (the difference between the two is the market risk premium).