Capital Asset Pricing Model
In 10 words or less: A model that allows you to price stocks and other securities.
Definition: A model that allows investors to price securities, such as stocks, based on the risk-free rate, market returns, and the security's volatility. The equation is characterized as:
ER_{k} = r_{f} + B_{k} (ER_{p} - r_{f}), where:
ER_{k} is the expected return on the stock for the year
r_{f} is the risk free rate of return
B_{k} is the beta of stock k
ER_{p} is the expected return on the market portfolio (typically the S&P500)
Advice: As long as you believe that beta is an accurate portrayal of a stock's risk relative to the market, CAPM is a great way to price securities. Many analysts use it to calculate a stock's cost of equity. |