The CAPM calculator can be used to solve problems based upon the Security Market Line (SML) from the Capital Asset Pricing Model. The calculator is able to solve for any of the four possible variables given the value of the other three variables.
1. Expected Return on Stock i Field - The Expected Return on Stock i is displayed or entered in this field.
2. Risk Free Rate Field - The Risk Free Rate is displayed or entered in this field.
3. Expected Return on the Market Field - The Expected Return on the Market Portfolio is displayed or entered in this field.
4. Beta for Stock i Field - The Beta for Stock i is displayed or entered in this field.
5. Buttons - Press these buttons to calculate the corresponding value.
o E[Ri] Button - Press to calculate the Expected Return on Asset i.
o Rf Button - Press to calculate the Risk Free Rate.
o E[Rm] Button - Press to calculate the Expected Return on the Market Portfolio.
o Beta Button - Press to calculate the Beta for Asset i.
Ri = Rf + βi *( Rm - Rf) ------ CAPM model
Ri = Expected return of investment
Rf = Risk-free rate
βi = Beta of the investment
Rm = Expected return of market
(Rm - Rf) = Market risk premium
For example, imagine an investor is contemplating a stock worth $100 per share today that pays a 3% annual dividend. The stock has a beta compared to the market of 1.3, which means it is riskier than a market portfolio. Also, assume that the risk-free rate is 3% and this investor expects the market to rise in value by 8% per year.
The expected return of the stock based on the CAPM formula is 9.5%.