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CAPM (Capital Asset Pricing Model)

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Finance & Accounting

Pages 7 (1757 words)

CAPM (Capital Asset Pricing Model) The CAPM model has emerged to be one of the most important tools in making a fundamental decision related to the investment management…

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## Introduction

and expected returns which is denoted as r. The ? is used as a measure of non diversified risk and implies that the expected return is the return on a risk free asset in addition to a risk premium (Laubscher, 2002). The risk premium will be equivalent to the market return in surplus of the risk free rate which is multiplied by the share portfolio. This is the reason that ? is regarded as the difference between the returns on various share portfolio. The formula for CAPM model is denoted below: R = Rf + ?(Rm - Rf) R = Expected return on the share/portfolio. Rf = Risk-free rate of return. ? = Beta (volatility of the share/portfolio relative to the market portfolio). Rm = Expected return on the market portfolio. Rm - Rf = Market risk premium (Laubscher, 2002). In the CAPM model risk is defined as the extent to which returns on share portfolio have covariance and variance with the market returns. ? is used for measuring risk and the basis for expected market returns. It is used as a measure for non diversified risk and is a relative measure of risk relative to the market portfolio. ...

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