1. What is the CAPM?

The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks. It's widely used throughout finance for pricing risky securities and generating expected returns.

2. How Does the Calculator Work?

The calculator uses the CAPM equation:

Where:

• \( R_f \) — Risk-free rate (%)
• \( \beta \) — Beta coefficient (unitless)
• \( R_m \) — Expected market return (%)
• \( (R_m - R_f) \) — Market risk premium

Explanation: The model shows that the expected return equals the risk-free rate plus a risk premium based on the asset's systematic risk (beta).

3. Importance of Cost of Equity

Details: Cost of equity is a crucial component in corporate finance for making investment decisions, valuing companies, and determining the weighted average cost of capital (WACC).

4. Using the Calculator

Tips: Enter risk-free rate (typically government bond yield), beta (from financial data providers), and expected market return (historical average or forecast). All values must be non-negative.

5. Frequently Asked Questions (FAQ)

Q1: What's a typical risk-free rate?
A: Usually the yield on 10-year government bonds (e.g., US Treasury notes for US companies).

Q2: How is beta determined?
A: Beta is calculated by regressing the stock's returns against the market's returns, typically using 3-5 years of monthly data.

Q3: What market return should I use?
A: Historical average market returns (typically 7-10% for US markets) or forward-looking estimates based on current conditions.

Q4: What are limitations of CAPM?
A: Assumes perfect markets, single-period time horizon, and that beta fully captures risk. Alternative models like Fama-French address some limitations.

Q5: How often should cost of equity be recalculated?
A: Should be updated when market conditions change significantly or when company risk profile changes.