1. What is the CAPM?

The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks. It is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital.

2. How Does the Calculator Work?

The calculator uses the CAPM equation:

Where:

• \( Risk-Free\ Rate \) — Typically the yield on government bonds (%)
• \( Beta \) — Measure of a stock's volatility compared to the market (unitless)
• \( Market\ Return \) — Expected return of the market portfolio (%)

Explanation: The model shows that the expected return on a security equals the risk-free return plus a risk premium based on the security's systematic risk (beta).

3. Importance of Cost of Equity Calculation

Details: The cost of equity represents the compensation the market demands in exchange for owning the asset and bearing the risk. It's crucial for investment decisions, corporate finance, and valuation models.

4. Using the Calculator

Tips: Enter the risk-free rate (typically 10-year government bond yield), the stock's beta (available from financial websites), and the expected market return (historical average is often used).

5. Frequently Asked Questions (FAQ)

Q1: What's a typical risk-free rate?
A: Usually the yield on 10-year government bonds. For US companies, the 10-year Treasury yield is commonly used.

Q2: How is beta determined?
A: Beta is calculated by regression analysis of a stock's returns against the market's returns. Most financial websites provide beta values for public companies.

Q3: What market return should I use?
A: Historical average market returns are often used (typically 7-10% for US markets). Some use forward-looking estimates based on current valuations.

Q4: What are limitations of CAPM?
A: Assumes markets are efficient, investors hold diversified portfolios, and beta remains stable over time - which may not always hold true.

Q5: When is CAPM most useful?
A: For publicly traded companies with established betas. For private companies, other methods may be more appropriate.