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Calculate expected return using the Capital Asset Pricing Model
CAPM is a financial model that calculates the expected return on an investment based on its systematic risk (beta), the risk-free rate, and the expected market return.
Treasury bill rate
S&P 500 avg: ~10%
Required return based on risk level
CAPM Formula
| Asset Type | Typical Beta | Description |
|---|---|---|
| Treasury Bonds | ~0 | Risk-free benchmark |
| Utilities | 0.3-0.6 | Defensive, stable |
| Consumer Staples | 0.6-0.9 | Low volatility |
| S&P 500 Index | 1.0 | Market benchmark |
| Technology | 1.2-1.5 | Growth-oriented |
| Small Cap Growth | 1.5-2.0 | High volatility |
Buy Signal
If actual expected return > CAPM expected return, the asset may be undervalued
Avoid Signal
If actual expected return < CAPM expected return, the asset may be overvalued
Fair Value
If actual return ≈ CAPM return, the asset is fairly priced for its risk
Formula
E(R) = Rf + β × (Rm − Rf)E(R) = expected return on the asset
Rf = risk-free rate (typically 3-month T-bill or 10-year Treasury yield)
β (beta) = sensitivity of the asset's return to market movements
(Rm − Rf) = market risk premium — extra return investors demand above risk-free rate
Worked Example
Rf = 4.5%, β = 1.2, Rm = 10%
Did you know? CAPM was developed independently by William Sharpe (1964), John Lintner (1965), and Jan Mossin (1966). Sharpe won the 1990 Nobel Prize in Economics partly for this contribution.
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