Description
The Capital Asset Pricing Model (CAPM) is a widely used financial model that calculates the expected return on an investment based on its risk and the overall market's risk. CAPM helps investors quantify the relationship between risk and expected return by taking into account the investment's sensitivity to market movements (beta), the risk-free rate of return (typically represented by government bond yields), and the market risk premium (the excess return expected from investing in the market over the risk-free rate). The formula for CAPM is expressed as the risk-free rate plus the beta of the investment multiplied by the market risk premium. CAPM assumes that investors are rational and risk-averse, seeking higher returns for higher levels of risk. It provides a valuable tool for estimating the appropriate rate of return for an investment relative to its risk, aiding in portfolio construction, asset allocation, and investment decision-making processes.