# Capital Asset Pricing Model (CAPM)

• What is CAPM?
• CAPM Assumptions
• CAPM Formula
• How to calculate CAPM?

## Capital Asset Pricing Model

CAPM stands for Capital Asset Pricing Model. Capital Asset Pricing Model (CAPM) defines the relationship between risk and required returns in the security market and it is used in the pricing of risky securities.

## CAPM Model Assumptions

1. Mean-Standard Deviation Analysis: We started out by assuming that individual’s preferences can be represented in terms of the mean and standard deviation of returns.

2. Investors’ Identical Believes: All investors are rational, have identical subjective estimates of the means, the variances, and covariance of returns of all assets.

3. Unlimited borrowing and lending: All investors can borrow or lend an unlimited amount at an exogenously given risk-free rate of interest.

4. Perfect markets: Markets are friction-less and there are no transactions costs. All assets are perfectly divisible, perfectly liquid so that they can be sold immediately at the market price.

5. Same after-tax returns: Taxes must be such that after-tax returns ensure that everybody faces the same efficiency locus.

6. Perfect Information: All investors have access to same information and analyze the information in the same manner.

#### How to Calculate CAPM?

As an analyst, you could use CAPM to decide what price you should pay for a particular stock. If Stock A is riskier than Stock B, the price of Stock A should be lower to compensate investors for taking on the increased risk.

CAPM Formula

The Capital Asset Pricing Model is given below:

ra = rrf + βa (rm-rrf)

where:

rrf = the rate of return on risk-free securities
rm = market’s expected rate of return
βa = beta of the asset

Capital Asset Pricing Model (CAPM) Definition, CAPM Assumptions and CAPM CalculationCapital Budgeting TechniquesCapital Asset Pricing Model (CAPM) What is CAPM? CAPM Assumptions  CAPM Formula How to calculate CAPM? Capital Asset Pricing Model CAPM stands for Capital Asset Pricing Model. Capital Asset Pricing Model (CAPM) defines the relationship between risk and required returns in the security market and it is used in the pricing of risky securities. CAPM Model... 