Understanding the CAPM Formula
The Capital Asset Pricing Model (CAPM) is a cornerstone of modern finance. It describes the relationship between systematic risk and expected return for assets.
- Risk-Free Rate (Rf): The theoretical rate of return of an investment with zero risk. The yield on a long-term government bond (like a 10-year U.S. Treasury note) is often used as a proxy.
- Beta (β): A measure of a stock's volatility in relation to the overall market. A beta of 1 means the stock moves with the market. A beta > 1 is more volatile, and a beta < 1 is less volatile.
- Market Rate of Return (Rm): The expected return of the overall market, often represented by the historical average return of a major index like the S&P 500.