1. What is the CAPM Model?

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.

2. How Does the Calculator Work?

The calculator uses the CAPM equation:

Where:

• \( E[R_{stock}] \) — Expected return on the stock
• \( R_f \) — Risk-free rate (typically 10-year Treasury yield)
• \( \beta \) — Beta coefficient (measure of stock's volatility relative to market)
• \( R_m \) — Expected market return

Explanation: The model shows that the expected return equals the risk-free rate plus a risk premium based on the stock's beta.

3. Importance of Expected Return Calculation

Details: CAPM helps investors assess whether a stock is fairly valued given its risk level. It's used in portfolio construction, corporate finance, and valuation models.

4. Using the Calculator

Tips: Enter risk-free rate and market return as percentages (e.g., 2.5 not 0.025). Beta should be entered as a decimal (e.g., 1.2 for a stock that's 20% more volatile than the market).

5. Frequently Asked Questions (FAQ)

Q1: What's a typical risk-free rate?
A: Usually the yield on 10-year government bonds (e.g., 2-5% depending on economic conditions).

Q2: How do I find a stock's beta?
A: Betas are published by financial data providers. A beta of 1 means the stock moves with the market, <1 means less volatile, >1 means more volatile.

Q3: What market return should I use?
A: Historical average market returns are often used (typically 7-10% for US markets long-term).

Q4: What are CAPM's limitations?
A: Assumes markets are efficient, investors hold diversified portfolios, and beta remains stable over time - which may not always be true.

Q5: Can CAPM be used for any asset?
A: Best suited for publicly traded stocks. Less reliable for private companies or assets without clear market comparables.