Definition of Capital Asset Pricing Model (CAPM)?

The Capital Asset Pricing Model, or CAPM, is one of the most commonly used models for calculating the expected return on an asset and is used to price securities.

The CAPM requires 3 data inputs:

• Beta of the asset (how much it moves relative to the market)
• Risk free rate (i.e. government bond yield)
• Expected return of the market (i.e. S&P return)

With all these figures, the calculation for the expected return is:

• Expected Return on Asset = Risk Free Rate + (Beta Asset x [Expected Market Return - Risk Free Rate])