Capital Asset Pricing Model (CAPM)

Overview

What if you could predict how much return you should expect from an investment based on its risk? That's where the Capital Asset Pricing Model, or CAPM, comes in. Used by investors and managers to estimate the expected return on an asset, CAPM connects risk and return through a simple yet powerful formula. At its core, the model shows how an asset's expected return depends on the risk-free rate, market risk premium, and the asset's beta. Visualizing CAPM reveals a straight line, with beta on the x-axis and expected return on the y-axis. By plugging in the right numbers, you can determine whether an investment is fairly priced. CAPM is a cornerstone of modern finance, helping guide decisions from portfolio management to corporate finance.