Question

Can anyone provide a clear and intuitive explanation of the Capital Asset Pricing Model (CAPM) (graphical and mathematical derivations welcome)

Answer 1

Answer-

Capital Asset Pricing Model (CAPM)

Steps for CAPM
1) Estimate the rislk free rate such as the yields of US treasury notes.R(f)
2) Calculate the stock beta. [Beta (i)]
3) Estimate the expected return on market (E (R mkt)
4) Using the CAPM equation to estimate the required rate of return. (E (R i))

E (R i) = R(f) + Beta (i) x [ E (R mkt) - R(f) ]

In CAPM at equilibrium is the expected return (E (Ri) on risky asset and calculated as the summation of Risk free rate (R (f) ) and beta-adjusted market risk premium   Beta (i) x [ E (R mkt) - R(f) ].

Beta measures the systematic or market risk. It measures the relation between the security's excess returns and the excess return for market portfolio.

Given below is the graphical method of CAPM

E(E Security Mayhet Ilime (SML) ElAm)- Magiel posttolic RF) B 1 Belen Syste matic RisK %3D Beki CApitd Aset pricing nadel (capm)