Capital Asset Pricing Model: Difference between revisions
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Once the expected return, E(R<sub>i</sub>), is calculated using CAPM, the future cash flows of the asset can be [[discounted]] to their [[present value]] using this rate to establish the correct price for the asset. |
Once the expected return, E(R<sub>i</sub>), is calculated using CAPM, the future cash flows of the asset can be [[discounted]] to their [[present value]] using this rate to establish the correct price for the asset. |
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* [http://www.riskglossary.com/articles/capital_asset_pricing_model.htm CAPM article on RiskGlossary.com] |
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Revision as of 21:34, 14 May 2004
The Capital Asset Pricing Model (CAPM) is used in finance to determine a theoretically appropriate price of an asset such as a security.
The formula takes into account the asset's sensitivity to non-diversifiable risk (aka. systematic risk or market risk), in a number often referred to as beta in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset.
The relationship is:
E(Ri) = Rf + betai x [E(Rm) - Rf]
Where:
E(Ri) = The expected return on the capital asset,
betai = The sensitivity of the asset returns to market returns,
E(Rm) = The expected return of the market, and
Rf = The risk-free rate of interest.
Once the expected return, E(Ri), is calculated using CAPM, the future cash flows of the asset can be discounted to their present value using this rate to establish the correct price for the asset.