CAPM
Calculate expected return using the CAPM formula: R = Rf + β(Rm - Rf). Enter risk-free rate, beta, and market return to estimate required equity return.
About This Calculator
The Capital Asset Pricing Model (CAPM) Calculator helps investors, analysts, and finance students estimate the expected return on an equity investment based on its systematic risk. Developed by William Sharpe in the 1960s, CAPM remains one of the most widely used models in corporate finance for calculating the cost of equity and evaluating investment opportunities.
The CAPM formula is: R = Rf + β × (Rm - Rf), where Rf is the risk-free rate (typically a government bond yield), β (beta) measures the asset's sensitivity to market movements, and Rm is the expected return of the broad market. The difference (Rm - Rf) is the market risk premium, representing the additional return investors demand for bearing systematic risk.
CAPM is based on the principle that investors should only be compensated for systematic (undiversifiable) risk, which beta captures. Diversifiable risk can be eliminated through portfolio diversification and therefore does not require a risk premium.
Regional Notes
India: Use the 10-year government bond yield (~6-7%) as risk-free rate. The Nifty 50 index is commonly used as the market benchmark. Historical equity risk premium in India ranges from 6-8%.
United States: Use the 10-year Treasury yield (~4-5%) as risk-free rate. The S&P 500 is the standard market benchmark. Historical equity risk premium averages 5-7% over the long term.
United Kingdom: Use the 10-year gilt yield (~4-4.5%) as risk-free rate. The FTSE 100 is the primary market benchmark. Historical UK equity risk premium averages 4-6%.
Beta values for individual stocks can be found on financial data platforms like Bloomberg, Reuters, Yahoo Finance, or from your brokerage. For portfolios, the weighted average beta of individual holdings provides the portfolio beta.
Frequently Asked Questions
What is the CAPM formula?
The CAPM formula is R = Rf + β × (Rm - Rf), where R is the expected return, Rf is the risk-free rate, β (beta) measures systematic risk, and Rm is the expected market return. The term (Rm - Rf) is called the market risk premium.
How do you interpret beta in CAPM?
Beta measures the sensitivity of a stock's returns to market movements. A beta of 1 means the stock moves with the market. A beta above 1 indicates higher volatility than the market, while a beta below 1 indicates lower volatility. A beta of 0 means the stock is uncorrelated with market movements.
What is a good risk-free rate to use for CAPM?
The risk-free rate is typically the yield on long-term government bonds. In India, use the 10-year government bond yield (around 6-7%). In the US, use the 10-year Treasury yield (around 4-5%). In the UK, use the 10-year gilt yield (around 4-4.5%).
Is CAPM still relevant for modern investing?
Yes, CAPM remains a foundational model in finance for estimating the cost of equity and expected returns. Despite its simplifying assumptions, it provides a useful framework for understanding the relationship between systematic risk and required return. Many practitioners use it alongside other models.
What are the limitations of the CAPM model?
CAPM relies on several simplifying assumptions including that investors are rational, markets are efficient, there are no transaction costs, and all investors have the same expectations. Real-world deviations from these assumptions can lead to inaccurate estimates. Beta itself can also be unstable over time.
What is the difference between CAPM and the Security Market Line?
CAPM is the model that produces the formula R = Rf + β × (Rm - Rf), while the Security Market Line (SML) is the graphical representation of CAPM. The SML plots expected return on the vertical axis against beta on the horizontal axis, showing the linear relationship between systematic risk and expected return.
How do you calculate the market risk premium for CAPM?
The market risk premium is calculated as the expected market return minus the risk-free rate. Practitioners often estimate this using historical averages. In India, the historical equity risk premium ranges from 6-8%. In the US, the historical S&P 500 risk premium has averaged around 5-7% over the long term.
Can CAPM be used for non-equity investments?
While CAPM was originally developed for equities, it can be applied to any asset class where a beta can be estimated relative to the market. Real estate, bonds, and even projects can use CAPM to estimate required returns, though the beta estimation becomes more challenging for non-traded assets.