CapitalAssetPricingModel(CAPM)Definition|Investopedia

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Capital Asset Pricing Model - CAPM

DEFINITION of 'Capital Asset Pricing Model - CAPM'
A model that describes the relationship between risk and expected
return and that is used in the pricing of risky securities
securities..

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The general idea behind CAPM is that investors need to be

compensated in two ways: time value of money and risk. The time
value of money is represented by the risk-free (rf) rate in the formula
and compensates the investors for placing money in any investment
over a period of time. The other half of the formula represents risk and calculates the amount
of compensation the investor needs for taking on additional risk. This is calculated by taking a
risk measure (beta) that compares the returns of the asset to the market over a period of time
and to the market premium (Rm-rf).

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FINANCIAL MODELING

INHERENT RISK

SYSTEMIC RISK

SYSTEMATIC RISK

BREAKING DOWN 'Capital Asset Pricing Model - CAPM'

The CAPM says that the expected return of a security or a portfolio equals the rate on a riskfree security plus a risk premium.
premium. If this expected return does not meet or beat the required
return, then the investment should not be undertaken. The security market line plots the
results of the CAPM for all different risks (betas).
Using the CAPM model and the following assumptions, we can compute the expected return
of a stock in this CAPM example: if the risk-free rate is 3%, the beta (risk measure) of the
stock is 2 and the expected market return over the period is 10%, the stock is expected to
return 17% (3%+2(10%-3%)).
Wants to know more about CAPM? Read Taking Shots at CAPM and The Capital Asset
Pricing Model: An Overview

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Inherent Risk
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CapitalAssetPricingModel(CAPM)Definition|Investopedia

The process by which a firm constructs a

financial representation ...

The risk posed by an error or omission in a

financial statement ...

Systemic Risk

Systematic Risk

Risk Parity

Risk-On Risk-Off

Investopedia explains: A systemic risk is the

possibility that ...

The risk inherent to the entire market or

entire market segment. ...

A portfolio allocation strategy based on

targeting risk levels ...

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An investment setting in which price

behavior responds to, and ...

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Expected Range of Return

Starting Balance

$17.5k

$ 1,000

$15k
$12.5k
$10k
$7.5k
$5k

Stocks

65%

Bonds

30%

Cash

5%

$2.5k
$0
2020

Overview

2025

2030

Details

2035

2040

2045

Year

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Systematic Risk
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CapitalAssetPricingModel(CAPM)Definition|Investopedia
Systematic risk, also known as volatility, non-diversifiable risk or market
risk, is the risk everyone assumes when investing in a market. Think of it as
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RELATED FAQS
Q: What is the formula for calculating the capital asset pricing model (CAPM) in Excel?
A: The capital asset pricing model (CAPM) measures the amount of an asset's expected return given the
risk-free rate, the beta ... Read Full Answer >>

Q: What types of risk are incorporated in Security Market Line (SML) analysis?
A: The security market line (SML) is a line plot that graphs an investment's risk versus its return.
Essentially, it is a graph ... Read Full Answer >>

Q: How is the Capital Asset Pricing Model (CAPM) represented in the Security Market ...
A: The capital asset pricing model (CAPM) is a measure that describes the relationship between the

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CapitalAssetPricingModel(CAPM)Definition|Investopedia

A: The capital asset pricing model (CAPM) is a measure that describes the relationship between the
systematic risk of a security ... Read Full Answer >>

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Q: According to the CAPM, the expected return on a stock, that is part of a portfolio, ...
A: A. the covariance between the stock and the market.B. the variance of the market.C. the market risk
premium.D. ... Read Full Answer >>

Q: What is the difference between systemic risk and systematic risk?

A: Systemic risk is generally used in reference to an event that can trigger a collapse in a certain industry
or economy, whereas ... Read Full Answer >>

Q: What are the risks of having both high operating leverage and high financial leverage?
A: In finance, the term leverage arises often. Both investors and companies employ leverage to generate
greater returns on their ... Read Full Answer >>

Q: Why should investors pick less risky investments as they approach retirement?
A: Investors must decide for themselves what the term "risky investment" means to them. At age 25, you
may feel comfortable ... Read Full Answer >>

Q: What are the components of the risk premium for investments?

A: The risk premium is the excess return above the risk-free rate that investors require as compensation
for the higher uncertainty ... Read Full Answer >>

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