Capital asset pricing model
The model in which expected return is the risk-free rate plus beta times the market risk premium. Only market risk is paid for, since other risk can be diversified away.
Where you will meet it
Capital asset pricing model appears in 14 learning outcomes on the CFA syllabus. A few of them:
- Estimate the return equity holders require with both the market model and the CAPM
“The capital asset pricing model estimates the required return on equity as the risk-free rate plus beta times the equity risk premium: r = Rf + beta x (E(Rm) - Rf).”
- Derive a stock's alpha and beta by regressing its excess returns on those of the market
“Regressing a stock's excess return on the market's excess return, Ri - Rf = a + b x (Rm - Rf) + e, estimates the inputs of the capital asset pricing model.”
- Explain the market portfolio and the idea of two-fund separation
“If all investors hold the same risky portfolio, it must in equilibrium be the market portfolio, which is the logical step that takes the framework from the capital allocation line to the capital market line and the CAPM.”
- Work out the cost of both common and preferred equity
“The capital asset pricing model estimates it as the risk-free rate plus beta times the equity risk premium.”
See also
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Practise capital asset pricing model until it is automatic: questions that explain every wrong option.
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