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 for assets given the risk of those assets and cost of capital.

2. How Does the Calculator Work?

The calculator uses the CAPM equation:

Where:

• \( E[R_{market}] \) — Expected market return
• \( R_f \) — Risk-free rate (typically 10-year Treasury yield)
• \( \beta \) — Beta coefficient (measure of systematic risk)
• \( R_m - R_f \) — Market risk premium

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

3. Importance of Expected Return Calculation

Details: Calculating expected returns helps investors make informed decisions about asset allocation, portfolio construction, and security valuation.

4. Using the Calculator

Tips: Enter the current risk-free rate (as percentage), the stock's beta coefficient, and the market risk premium (as percentage). All values must be non-negative.

5. Frequently Asked Questions (FAQ)

Q1: What is a typical risk-free rate?
A: The 10-year U.S. Treasury yield is commonly used, typically ranging between 1-5% in recent years.

Q2: How is beta determined?
A: Beta is calculated via regression analysis against a market index. A beta of 1 means the security moves with the market.

Q3: What's a reasonable market risk premium?
A: Historically, the U.S. equity risk premium has averaged about 5-6% over the risk-free rate.

Q4: Are there limitations to CAPM?
A: Yes, CAPM makes several unrealistic assumptions and may not fully capture real-world market behavior.

Q5: Can CAPM be used for individual stocks?
A: Yes, though the model works best for diversified portfolios. Individual stock returns may deviate significantly from CAPM predictions.