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Capital Asset Pricing Model (CAPM):
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The Capital Asset Pricing Model (CAPM) calculates the expected return on an investment based on its systematic risk. It provides a theoretical estimate of the appropriate required rate of return for an asset given its risk relative to the market.
The calculator uses the CAPM formula:
Where:
Explanation: The equation calculates the minimum return an investor should accept for investing in a particular stock, considering the risk-free return and the stock's volatility relative to the market.
Details: The required rate of return is crucial for investment decisions, portfolio management, and capital budgeting. It helps investors determine if an investment is worthwhile by comparing expected returns to required returns.
Tips: Enter risk-free rate as a percentage (typically government bond yield), beta coefficient (measure of stock volatility), and expected market return. All values must be valid numerical inputs.
Q1: What is a typical risk-free rate?
A: The risk-free rate is typically based on government bond yields, such as 10-year Treasury bonds, which historically range from 2-5%.
Q2: How is beta coefficient determined?
A: Beta is calculated by comparing a stock's returns to market returns over time. A beta of 1 means the stock moves with the market, below 1 is less volatile, above 1 is more volatile.
Q3: What is a reasonable market return expectation?
A: Historical market returns average around 7-10% annually, though this varies by market conditions and time period.
Q4: Are there limitations to the CAPM model?
A: Yes, CAPM assumes efficient markets, rational investors, and that beta fully captures risk. It may not account for all risk factors in real markets.
Q5: How often should required rate of return be recalculated?
A: It should be updated regularly as market conditions, interest rates, and company fundamentals change over time.