CAPM Meaning and
Definition
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Capital Asset Pricing Model (CAPM) is a financial model that is used to determine the appropriate expected return on an investment, taking into consideration the systematic risk associated with that investment. It is a widely used tool in modern financial theory.
The CAPM equation calculates the expected return on an investment by combining several variables. It states that the expected return on an investment equals the risk-free rate plus a risk premium, which is determined by multiplying the beta of the investment by the market risk premium. The risk-free rate is the return on a risk-free investment, such as a government bond, while the beta measures the sensitivity of the investment's returns to the overall market returns. The market risk premium represents the additional return an investor should expect to earn by investing in the market as a whole, rather than the risk-free rate.
The purpose of CAPM is to estimate the cost of equity for an investment, which is vital in determining the appropriate price to pay for a security or in evaluating investment opportunities. By using the CAPM, investors can assess the risk and return of an investment relative to the expected return of the overall market. This model assumes that investors are rational and risk-averse, and that they make decisions based on maximizing their expected returns while minimizing their risk. While the CAPM has its limitations, it remains an important tool in finance for understanding the relationship between risk and expected return.
Common Misspellings for CAPM
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- capnm
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- CAxM
- c apm
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