Capital Asset Pricing Model
A model that estimates the return required on an asset as the risk-free rate plus a premium proportional to its market risk.
Formula
Expected Return = Risk-Free Rate + Beta x (Expected Market Return - Risk-Free Rate)
Unit
%
In depth
CAPM's central claim is that only non-diversifiable risk deserves compensation, because company-specific risk can be diversified away at no cost — which is why beta, not total volatility, appears in the formula. Its empirical record is poor: realised returns do not line up with beta as tightly as the theory requires, and factors such as size and value explain returns the model does not. It survives because it is simple, teachable and produces a defensible number for a discount rate. Treat its output as a reasonable convention rather than a measurement.
Worked example
Risk-free rate 7%, market return 12%, beta 1.3. Required return = 7% + 1.3 x (12% - 7%) = 7% + 6.5% = 13.5%. A beta of 0.7 would give 7% + 3.5% = 10.5% for the same market assumptions.
Illustrative figures, chosen so the arithmetic is easy to follow. Not a live price and not a valuation of any company.
Educational reference only
This entry explains what “Capital Asset Pricing Model” means. It is not investment advice and not a recommendation to buy or sell any security. Any numbers above are illustrative, not live prices, and nothing here predicts price direction or rates a stock. Consider your own circumstances and consult a SEBI-registered investment adviser before acting.