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Capital asset pricing model

The capital asset pricing model (CAPM) is a way to theoretically calculate the appropriate rate of return of an asset (or stock).

Expanded Definition

The CAPM Formula is:

<math>E(Ra)=Rf+B(E(m)-Rf)\ </math>
where
<math>E(Ra)=Expected\ Return\ of\ Asset</math>
<math>Rf=Risk\ Free\ Rate</math>
<math>B=Beta\ of\ Security</math>
<math>E(Rm)=Expected\ Return\ of\ Market</math>

Some of the shortcomings with this model is that it is backward looking. Beta is a historical measure and therefore it might be more useful to calculate a firm's expected Beta. In addition, Beta is not really a useful measure of risk, instead it is a measure of volatility, which finance theorists like to use interchangeably with risk.

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