CAPM Equation

Understanding the Capital Asset Pricing Model (CAPM)

The Capital Asset Pricing Model (CAPM) is a fundamental theoretical model used to determine the expected return on a security or portfolio. This CAPM calculator enables you to quickly find the expected return on a stock using the CAPM formula.

If you are already familiar with CAPM, feel free to scroll down to the calculator. Otherwise, read on for a brief explanation.

What is the CAPM Formula?

The CAPM formula relates the expected return on a stock to its risk and the expected return on the market. The formula is as follows:

Expected Return=Risk-Free Rate+β×(Market Return−Risk-Free Rate)

Explanation of CAPM

In plain English:

• Risk-Free Rate: This is the rate of return you can expect from a riskless investment. Typically, the yield on a 6-month Treasury bond is used for this, as the U.S. government backs the interest and principal, making it virtually risk-free.
• Beta (β): Beta represents the stock’s risk relative to the market. If a stock’s beta is 2, it is twice as risky as the market. If the beta is 0.5, the stock is half as risky as the market.
• Market Risk Premium: This is the return on the market minus the risk-free rate of return. The return on the S&P 500 is usually used as the “market” return. For example, if the market return is 10% and the risk-free rate is 2%, the market risk premium is 8% (10% – 2%).

CAPM Example

Let’s go through an example. Suppose the risk-free rate is 2%, the market return is 10%, and the stock has a beta of 2. The expected return on the stock using CAPM would be:

Expected Return=2%+2×(10%−2%) Expected Return=2%+2×8% Expected Return=2%+16%=18%

CAPM Calculator

How to Use the CAPM Calculator

To use the calculator, simply input the following values into the appropriate fields:

• Risk-Free Rate: You can find current Treasury yields here.
• Beta: You can look up a stock’s beta on Yahoo! Finance or other financial websites.
• Market Return: While these values should ideally be forward-looking, historical data often serves as a proxy for future returns. Historical S&P 500 return data can be found here.