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    CAPM — Capital Asset Pricing Model

    CAPM calculates the expected return on an investment based on its systematic risk (beta). It's fundamental to stock valuation and portfolio management.

    Capital Asset Pricing Model

    E(R) = Rf + Beta × (Rm - Rf)

    Where:

    • E(R) = Expected return on the stock
    • Rf = Risk-free rate (government bond yield)
    • Beta = Stock's sensitivity to market movements
    • Rm = Expected market return

    Step-by-Step:

    1. 1

      Find risk-free rate

      Use 10-year government bond yield (currently ~7% in India).

    2. 2

      Find beta

      Available on financial websites. Beta >1 = more volatile than market.

    3. 3

      Estimate market return

      Historical Nifty returns: ~12%. Market premium = Rm - Rf.

    4. 4

      Apply CAPM

      Expected return = Rf + Beta × (Rm - Rf).

    Worked Examples:

    Stock expected return

    Rf: 7%Beta: 1.3Rm: 12%

    Result: E(R) = 13.5%

    7% + 1.3 × (12% - 7%) = 7% + 6.5% = 13.5% expected return

    Frequently Asked Questions