The Capital Asset Pricing Model (CAPM) is a widely used financial model that calculates the expected return of an investment based on its risk and the return of the overall market. In this article, we’ll go over the steps to calculate the CAPM for a stock or other investment.

- Determine the risk-free rate of return: The first step in calculating the CAPM is to determine the risk-free rate of return. This is typically the return on a secure investment, such as a Treasury bond.
- Determine the expected market return: The next step is to determine the expected return of the overall market. This can be done by looking at historical returns or by making an estimate based on current market conditions.
- Calculate the beta (risk) of the investment: Beta is a measure of the risk of an investment relative to the market. It is calculated by dividing the covariance of the investment’s returns and the market’s returns by the variance of the market’s returns. A beta of 1 indicates that the investment’s returns are in line with the market, while a beta greater than 1 indicates that the investment is riskier than the market, and a beta less than 1 indicates that the investment is less risky than the market.
- Calculate the expected return: To calculate the expected return using the CAPM, the following formula is used:

Expected return = Risk-free rate + Beta (Expected market return – Risk-free rate)

- Interpret the results: The result of the CAPM calculation is the expected return of the investment. This can be used to compare the expected return of different investments and to make informed investment decisions.

## CAPM formula:

The Capital Asset Pricing Model (CAPM) formula is used to determine the expected return of an investment based on its risk and the return of the overall market. The formula is as follows:

Expected return = Risk-free rate + Beta (Expected market return – Risk-free rate)

The variables in the formula are defined as follows:

- Risk-free rate: This is the return on a secure investment, such as a Treasury bond, that is used as a benchmark for determining the expected return of an investment.
- Beta: This is a measure of the risk of an investment relative to the market. It is calculated by dividing the covariance of the investment’s returns and the market’s returns by the variance of the market’s returns. A beta of 1 indicates that the investment’s returns are in line with the market, while a beta greater than 1 indicates that the investment is riskier than the market, and a beta less than 1 indicates that the investment is less risky than the market.
- Expected market return: This is the expected return of the overall market, which can be determined by looking at historical returns or by making an estimate based on current market conditions.

By plugging in the values for the risk-free rate, beta, and expected market return into the CAPM formula, we can calculate the expected return of an investment. This can be used to compare the expected return of different investments and to make informed investment decisions.

In conclusion, the CAPM is a useful tool for investors to determine the expected return of an investment based on its risk and the return of the overall market. By following the steps outlined in this article, you can calculate the CAPM for a stock or other investment and make informed investment decisions.