CAPM Formula Template
This CAPM formula template will help you calculate the required rate of return for investing in a security given the risk-free return and risk premium.
This is what the CAPM template looks like:
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The Capital Asset Pricing Model (CAPM) describes the relationship between expected return and risk of investing in a security. It shows that the expected return on a security is equal to the risk-free return plus a risk premiumEquity Risk PremiumEquity risk premium is the difference between returns on equity/individual stock and the risk-free rate of return. It is the compensation to the investor for taking a higher level of risk and investing in equity rather than risk-free securities., which is based on the betaUnlevered Beta / Asset BetaUnlevered Beta (Asset Beta) is the volatility of returns for a business, without considering its financial leverage. It only takes into account its assets. It compares the risk of an unlevered company to the risk of the market. It is calculated by taking equity beta and dividing it by 1 plus tax adjusted debt to equity of that security.
The formula for calculating CAPM is as follow:
Expected return on a security = Risk-free rate + Beta of the security * (Expected return on market – Risk-free rate)
It is based on the premise that investors have assumptions of systematic riskSystematic RiskSystematic risk is that part of the total risk that is caused by factors beyond the control of a specific company or individual. Systematic risk is caused by factors that are external to the organization. All investments or securities are subject to systematic risk and therefore, it is a non-diversifiable risk. (also known as market risk or non-diversifiable risk) and need to be compensated for it in the form of a risk premiumMarket Risk PremiumThe market risk premium is the additional return an investor will receive (or expects to receive) from holding a risky market portfolio instead of risk-free assets. The market risk premium is part of the Capital Asset Pricing Model (CAPM) which analysts and investors use to calculate the acceptable rate – an amount of market return greater than the risk-free rate. By investing in a security, investors want a higher return for taking on additional risk.
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