Pronounced as though it were spelled cap-m, this model was originally developed in 1952 by Harry Markowitz and fine-tuned over a decade later by others, including William Sharpe. CAPM describes the relationship between risk and expected return, and it serves as a model for the pricing of risky securities. 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 our required return, the investment should not be undertaken.
The commonly used formula to describe the CAPM relationship is as follows:
Required (or expected) Return = RF Rate + (Market Return – RF Rate)*Beta Continue reading “Capital Asset Pricing Model (CAPM)”