Capital Asset Pricing Model - CAPM
Definition of '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.
Investopedia explains 'Capital Asset Pricing Model - CAPM'
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%)).
Wants to know more about CAPM? Read Taking Shots at CAPM and The Capital Asset Pricing Model: An Overview