Glossary

Capital Asset Pricing Model (CAPM)

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The Capital Asset Pricing Model (CAPM) helps investors calculate the expected return on investment while taking into account its risk. The CAPM takes into account the risk free return, risk premium, and the beta. The risk premium is the return you expect to earn on an investment because of the risk which you take on as an investor.

CAPM says that the money you can expect to make from an investment is equal to the safe, risk-free return plus the extra risk premium (based on how risky the investment is). So, riskier investments should give you higher returns than safer investments to make up for the risk you’re taking.

Related Terms
Risk Free Rate
The risk-free rate is the rate of return an investor can receive from an investment which is considered to be riskless. In the United States, the risk-free rate is often referring to the yield on the three-month U.S. Treasury bill.
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Beta
Beta is a measure of the volatility of a stock or portfolio compared to the market as a whole. Beta is used to describe and price the risk of securities based on their volatility compared to the rest of the market, the risk of those assets, and the cost of capital.
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