Capital Asset Pricing Model

CAPM
D/Ahmed EL Otiefy
 What is the CAPM (Capital Asset Pricing Model)

Every investment comes up with a certain risk. Even

equity has the risk that there might be a difference
between the actual and the expected return..
Investors being conservative by nature decide to
take the risk only when they can foresee the return
they are expecting from an investment. Investors
can calculate and get an idea of the required return
on investment based on the assessment of its risk
using CAPM (Capital Asset Pricing Model)
 Calculation of CAPM (Capital Asset Pricing Model)

Cost of equity = Risk-free rate + Beta X ( Market return -Risk free)

Cost of equity (Ke) = the rate of return expected by shareholders
Risk-free rate (rrf ) = the rate of return for a risk-free security
Risk premium ( Rp) = the return that equity investors demand over a risk-
free rate
Beta (Ba) = A measure of the variability of a company’s stock price in
relation to the stock market overall
 Assumptions for the CAPM (Capital Asset Pricing Model) model

• Investors don’t like to take a risk. They would like to invest in a

portfolio that has low risk. So if a portfolio has a higher risk, the
investors expect a higher return.
• While making the investment decision, investors take into
consideration only a single period horizon and not multiple
period horizons.
• Transaction cost in the financial market is assumed to be low
cost, and the investors can buy and sell the assets in any
number at the risk-free rate of return.
• In CAPM (Capital Asset Pricing Model), Values need to be
assigned for the risk-free rate of return, risk premium, and beta
Security Market Line
Calculate and interpret the expected return of an asset using the
CAPM.

The CAPM is one of the most fundamental

concepts in investment theory. The CAPM
is an equilibrium model that predicts the
expected return on a stock, given the expected
return on the market, the stock's beta
coefficient, and the risk-free rate.
mispriced securities undervalued VS overvalued,