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What is CAPM (Capital Asset Pricing Model)?

What is CAPM (Capital Asset Pricing Model)?

The Capital Asset Pricing Model or CAPM is a financial theory that discusses expected rate of return and market risk. This can be used to determine the expected rate of return (expected return) compared to the risk of the invested securities. This risk is measured by Beta.

with the following equation:

return = risk free + beta✕(market return – risk free)

= risk free + beta✕(market premium)

Where risk free is the risk free interest rate or government bond interest rate.

Beta is a number obtained by comparing the direction of the return of the securities of interest to the rate of return of the market.

Market return is the rate of return of the market, for example, in Thailand, the rate of return of SET INDEX is approximately 8% – 12%.

market premium is risk compensation that the average equity investor needs calculated from the difference of Market return vs. risk free interest rate

Beta data can tell you the movement of a security in the past. However, as the future is uncertain, a security’s beta value may differ significantly from a variety of factors. that affect the stock price and market rate of return

If the security’s price moves in the same direction as the market, it has a beta of 1. If the security’s price is less than the market, it’s a beta of less than 1. If the security’s price is more than the market, it’s a beta of more than 1.

For example:

Entertainment Holdings has a beta of 1.25, a market yield of 10%, a government bond interest rate of 2.15%. Calculate the expected return on Entertainment Holdings Securities.

Return = risk free + beta✕(market return – risk free)

Return = 2.15% + 1.25✕(10% – 2.15%)

= 2.15% + 1.25✕(7.85%)

= 2.15% + 9.81%

= 11.96%