CAPM Abbreviation

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Popular abbreviations of CAPM:

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What does CAPM mean?

The full form of CAPM is the Capital Asset Pricing Model. The finance model CAPM attempts to explain the relationships between two important elements of an investment in securities and equity or stocks. These two elements are the systematic risks involved in the investment in stocks and expected returns on such an investment in securities or stocks.

Systematic Risks in investments in stocks and securities are the risks that are inalienable and inherent while investing in stocks and securities. While stock-related technical risks can be decreased via detailed technical choices and better diversification of stock portfolio, the Systemic Risks involved with the investments cannot be done away with. These inherent systematic risks with investments in stocks and securities include economic recession and wars.

Application

The Capital Asset Pricing Model is mainly associated with investments in stocks and securities which are considered risky. The Capital Asset Pricing Model acts as an effective tool while investing in risky securities or stocks as it helps to better calculate and assess the risks involved in risky investments. Additionally, the Capital Asset Pricing Model also helps to shape a prediction regarding the expected returns on such an investment in stocks or securities.

Capital Asset Pricing Model: Formula

The Capital Asset Pricing Model provides for a mechanism to assess the systematic risk in a stock or securities investment. The Capital Asset Pricing Model provides for a standard formula for the same which is as follows :

The expected return on a security or stock investment = Risk-Free Rate + Beta of the investment multiplied by the Market Risk premium.

The risk-free rate employed in the Capital Asset Pricing Model represents the time value of the money invested in the stock or securities. 

The ‘Beta’ of the investment is the figure used to represent the factor of risk that would be introduced to the investor’s investigation portfolio if the investment is made in the risky stock or security. However, in order to calculate the beta, the investor’s portfolio should also represent the market at large.