Capital Asset Pricing Model

The Capital Asset Pricing Model is a core tool in financial theory that helps assess the expected return on investments, taking risk into account.

The CAPM plays a crucial role in investment decision-making and portfolio formation.

Capital Asset Pricing Model:

• It helps investors determine what level of return justifies the risk they are taking.
• It is an effective method for valuing assets, investment projects, and managing risk.
• Is applied within the framework of a specific financial system
• It is based on the principle of equilibrium between the expected return of an investor’s asset portfolio and investment risk.
• Takes into account the level of systematic risk of a company relative to the overall stock market

Explained: Capital Asset Pricing Model

Model definition: CAPM relates the expected return of an asset to its systematic risk, expressed through the beta coefficient (β), which measures how sensitive the asset is to market changes.

What is the Capital Asset Pricing Model – For example:

Expected return = Risk-free rate + β × (Market return – Risk-free rate)

The model considers two types of risk:

• Systematic risk, which applies to the market portfolio
• Specific (unsystematic) risk, which is unique to each type of asset

The risk-free rate is defined as the minimum level of return that investors expect.