Capital Asset Pricing Model (CAPM) And Beta

The Capital Asset Pricing Model (CAPM) derives the expected return for an asset based upon the asset's systematic, or market, risk. CAPM assumes non-market, or unsystematic, risk can be removed through appropriate diversification. If an asset moves the same percentage as the market it has a beta of 1. If it moves proportional but greater than the market it has a beta greater than one and if it moves proportional but less than the market it has a beta less than one. This calculation expresses the expected return in terms of the market return, the risk free rate of return and beta.

Expected Return = Risk Free Return + Beta*(Market Return - Risk Free Return)

From 12/31/71 through 1/31/17 the Market Return as given by the S&P 500 was 10.39%. The Risk Free Rate of return as given by the 90-day T-Bill was 4.91%.

Portfolio returns can be increased by creating a portfolio with a beta greater than one, which leads to the possibility of creating a portfolio of high-beta stocks or using margin to create leverage and thereby increase beta.

Disclosure:

The information presented here is the opinion of the author and may quickly become outdated and is subject to change without notice. All material presented in this article are compiled from sources believed to be reliable, however accuracy cannot be guaranteed. No person should make an investment decision in reliance on the information presented here.

The information presented here is distributed for education purposes only and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or participate in any particular trading strategy.

Performance data showing past performance results is no guarantee of future returns.