- Capital Asset Pricing Model - CAPM
- A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities.
The general idea behind CAPM is that investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of time and to the market premium (Rm-rf).
The CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium. If this expected return does not meet or beat the required return, then the investment should not be undertaken. The security market line plots the results of the CAPM for all different risks (betas).
Using the CAPM model and the following assumptions, we can compute the expected return of a stock in this CAPM example: if the risk-free rate is 3%, the beta (risk measure) of the stock is 2 and the expected market return over the period is 10%, the stock is expected to return 17% (3%+2(10%-3%)).
Investment dictionary. Academic. 2012.
Look at other dictionaries:
capital asset pricing model — kapitalo įkainojimo modelis statusas T sritis turto vertinimas apibrėžtis Modelis, pagal kurį akcijų ar akcijų portfelio kapitalo kaina yra lygi nerizikingai palūkanų normai, pridėjus akcijų ar akcijų portfelio sistemos riziką atitinkantį rizikos … Lithuanian dictionary (lietuvių žodynas)
asset pricing model — A model for determining the required rate of return or expected rate of return on an asset. Related: capital asset pricing model and arbitrage pricing theory. Bloomberg Financial Dictionary … Financial and business terms
Capital asset — has two related meanings in the fields of accounting and financial economics. In accounting, a capital asset is an asset that is recorded on a balance sheet as capital that is, property that creates more property, e.g. a factory that creates… … Wikipedia
pricing model — ➔ model * * * pricing model UK US noun [C] ► COMMERCE, MARKETING a method for deciding what prices to charge for a company s products or services: »The change in the group s pricing model for its directory service saw it shift from charging… … Financial and business terms
arbitrage pricing model — noun An asset pricing model using one or more common factors to price returns. With only one factor, representing the market portfolio, it is called a single factor model. With two or more factors, it is called a multifactor model. See Also:… … Wiktionary
model — mod‧el [ˈmɒdl ǁ ˈmɑːdl] noun 1. [countable] a particular type or design of a vehicle or machine: • the cheapest model in the Volkswagen range • Our photocopier is the latest model. see also brand1, make2 … Financial and business terms
capital market line — ( CML) The line defined by every combination of the risk free asset and the market portfolio. The line represents the risk premium you earn for taking on extra risk. Defined by the capital asset pricing model. Bloomberg Financial Dictionary … Financial and business terms
Capital structure — Gearing ratio redirects here. For the mechanical concept, see gear ratio. Finance Financial markets … Wikipedia
Weighted average cost of capital — The weighted average cost of capital (WACC) is the rate that a company is expected to pay to finance its assets. WACC is the minimum return that a company must earn on existing asset base to satisfy its creditors, owners, and other providers of… … Wikipedia
Arbitrage Pricing Theory (APT) — An alternative model to the capital asset pricing model developed by Stephen Ross and based purely on arbitrage arguments. The New York Times Financial Glossary … Financial and business terms
arbitrage pricing theory — ( APT) An alternative model to the capital asset pricing model developed by Stephen Ross and based purely on arbitrage arguments. The APT implies that there are multiple risk factors that need to be taken into account when calculating risk… … Financial and business terms