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Capital asset pricing model equation11/24/2023 ![]() So in India, the risk-free rate is equivalent to that of the 10-year government bond yield, which is 7.3% in March 2023. Theoretically, certain securities have zero risk as they are backed by the government itself and are guaranteed to not default on payments. The risk-free rate is more or less constant and does cause any change in the ER computation. The expected return depends on the market volatility as well as the overall market’s rate of return. ![]() The expected rate of return is the percentage of return that the investor will earn on his investment throughout its lifespan. Now, let’s understand these terminologies in detail. Here, “(R m – R f)” is called the ‘market risk premium,’ which is the surplus return an investor will stand to make by holding on to the riskier security instead of holding on to risk-free security. Β = Market volatility of the security (can be found on any trading terminal) The formula for calculating the expected rate of return using CAPM is as follows: As we know what is the capital asset pricing model, let us now focus on the CAPM formula. The Capital Asset Pricing Model is used in finance to estimate the price as well as returns from investing in riskier securities. The CAPM model builds on the fact that high-risk investments also yield greater rewards. The CAPM computation uses the relationship between market volatility and this risk-free rate to arrive at this expected return. The CAPM model demonstrates a linear relationship between an asset’s expected rate of return (reward) and volatility (risk). The risk mentioned here is also called ‘systematic risk,’ and is unavoidable as it stems from market volatility. The Capital Asset Pricing Model is a financial framework that derives the estimated return on investment in a security based on the associated risk of investing in the market.
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