CAPM Calculator
Find expected return with the Capital Asset Pricing Model.
CAPM estimates the return investors should require for a stock's risk.
How the Math Works
The Capital Asset Pricing Model (CAPM) calculates the expected return of an investment by balancing its risk against the overall market. The formula E(R) = Rf + β × (Rm − Rf) breaks down as follows: Rf (risk-free rate) represents the return of a theoretically riskless asset, like government bonds. Rm is the expected market return, and β (beta) measures the investment's volatility relative to the market. The term (Rm − Rf) is the market risk premium, reflecting extra return demanded for taking on market risk. Multiplying this premium by beta scales the risk-adjusted return, so higher-beta investments (more volatile) require higher expected returns to compensate for their risk.
Practical Applications
Investors use CAPM to evaluate whether an investment's potential return justifies its risk. For example, if a stock has a beta of 1.2 and the current risk-free rate is 2% with a market return of 8%, the expected return would be 2% + 1.2 × (8% − 2%) = 9.2%. This helps determine if the stock is undervalued (offering higher returns than its risk warrants) or overvalued. Portfolio managers also apply CAPM to optimize asset allocation, ensuring their investments align with risk tolerance and return objectives by comparing calculated returns to actual or required returns.
Day-to-Day Use
CAPM empowers everyday investors to make informed decisions about their portfolios. By calculating expected returns based on risk, individuals can choose investments that match their financial goals—opting for low-beta stocks for stability or high-beta opportunities for growth. It also helps assess whether an investment's historical performance aligns with its risk profile, guiding choices like whether to hold or sell an asset. Understanding this model demystifies risk-reward trade-offs, enabling smarter budgeting, retirement planning, and wealth-building strategies without requiring advanced financial expertise.
Worked example
3% + 1.2 × (9% − 3%) → 10.2%.
FAQ
Beta?
Measures volatility vs the market (1 = market average).