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 (R_f): 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 (R_m): The expected return of the overall market, often represented by the historical average return of a major index like the S&P 500.