Capm Model Calculator

Risk-Free Rate (%):

Beta (β):

Expected Market Return (%):

function calculateCAPM() { var riskFreeRateInput = document.getElementById("riskFreeRate").value; var betaInput = document.getElementById("beta").value; var marketReturnInput = document.getElementById("marketReturn").value; var resultDiv = document.getElementById("capmResult"); var riskFreeRate = parseFloat(riskFreeRateInput); var beta = parseFloat(betaInput); var marketReturn = parseFloat(marketReturnInput); if (isNaN(riskFreeRate) || isNaN(beta) || isNaN(marketReturn)) { resultDiv.innerHTML = "Please enter valid numbers for all fields."; return; } // Convert percentages to decimals for calculation var riskFreeRateDecimal = riskFreeRate / 100; var marketReturnDecimal = marketReturn / 100; // CAPM Formula: Expected Return = Risk-Free Rate + Beta * (Market Return – Risk-Free Rate) var expectedReturnDecimal = riskFreeRateDecimal + beta * (marketReturnDecimal – riskFreeRateDecimal); // Convert back to percentage for display var expectedReturn = expectedReturnDecimal * 100; resultDiv.innerHTML = "The Expected Return (Re) is: " + expectedReturn.toFixed(2) + "%"; }

Understanding the Capital Asset Pricing Model (CAPM)

The Capital Asset Pricing Model (CAPM) is a widely used financial model that helps investors determine the expected return on an investment, given its risk. It provides a framework for assessing the required rate of return for an asset, which can then be used to make informed investment decisions.

The CAPM Formula

The core of the CAPM is its formula:

Expected Return (Re) = Risk-Free Rate (Rf) + Beta (β) × (Market Return (Rm) – Risk-Free Rate (Rf))

Components Explained:

Expected Return (Re): This is the return an investor can expect from an investment, considering its risk. It's the output of our calculator.
Risk-Free Rate (Rf): This represents the return on an investment with zero risk. Typically, the yield on a long-term government bond (like a U.S. Treasury bond) is used as a proxy for the risk-free rate. It compensates investors for the time value of money.
Beta (β): Beta is a measure of a stock's volatility in relation to the overall market. A beta of 1 indicates that the asset's price will move with the market. A beta greater than 1 suggests the asset is more volatile than the market, while a beta less than 1 suggests it's less volatile.
Expected Market Return (Rm): This is the return an investor expects from the overall market (e.g., the S&P 500). It's an estimate of the average return of all assets in the market.
Market Risk Premium (Rm – Rf): This is the difference between the expected market return and the risk-free rate. It represents the additional return investors demand for taking on the average market risk.

How to Use This Calculator:

Simply input the values for the Risk-Free Rate, Beta, and Expected Market Return into the respective fields. The calculator will then apply the CAPM formula to determine the Expected Return for your investment.

Example Calculation:

Let's say you have the following data for a particular stock:

Risk-Free Rate (Rf): 3%
Beta (β): 1.2
Expected Market Return (Rm): 10%

Using the CAPM formula:

Re = 0.03 + 1.2 × (0.10 – 0.03)
Re = 0.03 + 1.2 × 0.07
Re = 0.03 + 0.084
Re = 0.114 or 11.4%

This means, given the risk profile (beta) of this stock and the current market conditions, an investor would expect a return of 11.4%.

Limitations of CAPM:

While widely used, CAPM has its limitations:

Assumptions: It relies on several simplifying assumptions, such as efficient markets, rational investors, and no transaction costs, which may not hold true in the real world.
Historical Data: Beta is typically calculated using historical data, which may not be indicative of future volatility.
Market Portfolio: The "market portfolio" is theoretical and difficult to perfectly replicate in practice.
Single Factor Model: CAPM is a single-factor model (beta is the only risk factor). Other models, like the Fama-French three-factor model, incorporate additional factors.

Despite these limitations, CAPM remains a valuable tool for estimating the cost of equity and evaluating investment opportunities, especially when used in conjunction with other valuation methods.