The Capital Asset Pricing Model, or CAPM, is a tool that is used to estimate the return of a capital asset given the risk-free rate, the "beta" of the asset being invested in and the expected market return for that asset. The beta value is known as the non-diversifiable risk or systematic risk for any given asset.
Identify the risk-free rate of interest. The risk-free rate is the return rate for risk-free assets, such as government bonds. This is the Rf value in the formula.
Identify the beta value for the asset in question (the B value in our formula). This value can be obtained from information about the asset posted on any website that provides information about investment assets such as stocks or mutual funds.
Identify the market rate of return (Rm). This rate of return is usually calculated using the historical average on a market portfolio like the Dow Jones Industrial Average or the S&P 500.
Plug the values obtained into the following formula to obtain the estimated return (Ra): Ra = Rf + B*(Rm - Rf)
Nak Bhat started writing in 2009 for the automotive blog, Stance:Nation. He is also an event photographer for this blog. He is is a pre-law student working toward a Master of Law at Las Positas College.