1. What is the CAPM?

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:

• \( R_f \) — Risk-free rate (%)
• \( \beta \) — Beta coefficient (unitless)
• \( R_m \) — Expected market return (%)
• \( R_m - R_f \) — Market risk premium

Explanation: The model shows that the expected return on a security equals the risk-free return plus a risk premium based on the security's systematic risk (beta).

3. Importance of Cost of Equity

Details: Cost of equity is a crucial component in corporate finance for making investment decisions, evaluating projects, and determining a company's weighted average cost of capital (WACC).

4. Using the Calculator

Tips: Enter the risk-free rate (typically government bond yield), the stock's beta coefficient, and the expected market return. All values must be non-negative.

5. Frequently Asked Questions (FAQ)

Q1: What does CAPM calculate?
A: CAPM calculates the expected return (cost of equity) an investor should require for a particular investment given its systematic risk.

Q2: What is a typical risk-free rate?
A: Typically the yield on 10-year government bonds is used (e.g., 10-year Treasury yield for US investments).

Q3: How is beta determined?
A: Beta is calculated by regressing the stock's returns against the market's returns. A beta of 1 means the stock moves with the market.

Q4: What are CAPM's limitations?
A: Assumes markets are efficient, investors hold diversified portfolios, and that beta remains stable over time.

Q5: What market return should I use?
A: Historical market returns (typically 7-10% for US markets) or forward-looking estimates based on current valuations.