Explaination of CAPM The Capital Asset Pricing Model (CAPM) is a financial model used to determine the expected return on an investment, given its risk relative to the overall market. The critical component of CAPM is the beta ( β) value, which measures the sensitivity of an asset's returns compared to the market as a whole.
β=1: The asset moves with the market. β>1: The asset is more volatile than the market. β<1: The asset is less volatile than the market.
CAPM Formula:
Ra = Rf + β(Rm - Rf) where: Rf = The return on a risk-free investment, such as government bonds. Rm = The expected return of the overall market.
In summary, CAPM helps investors understand how much return they should expect from an asset, considering its risk (beta) relative to the broader market.