Question

Does anyone have questions and answers about the Capital Asset Pricing Model (CAPM)? (so I can test my understanding)

Answer 1

In finance, there is a concept called Capital Asset Pricing Model (CAPM) to calculate expected return on stock. This model takes into account all varients associated with the stocks such as Treasury bills' yield rate, beta coefficient in terms of risks associated with stock with respect to payment of periodic coupons as well as repayment of principal at maturity and investors' return expected in the market. Algebrically, expected return on stock is the sum of risk-free rate and beta times the market risk premium. Here, risk-free rate is nothing but the treasury bill's yield rate as investors' risk on such T-bills are nothing. Market risk premium is the difference between investors' expected return on stock in the market and T-bills' yield rate. In order to calculate expected return on stock, market risk premium is multiplied by beta and the result is added to T-bills' yield rate. For Example, let the Treasury bond's yield rate be 4%; market investors' expected return on stocks be 9%; Beta associated with the stock be 1.1 (which means that risks associated with the stock is higher). Using CAPM, Expected return on stock = Risk-free Rate + (Beta x Market Risk Premium) Expected return on stock = Risk-free Rate + [Beta x (Market Return - Risk-free Rate)] Expected return on stock = 4% + [1.1 x (9% - 4%)] Expected return on stock = 4% + [1.1 x 5%] Expected return on stock = 4% + 5.5% Expected return on stock = 9.5% %3D