The formula used by the CAPM to calculate the expected return is:
\[ E(R_i) = R_f + [E(R_m) - R_f] \times \beta_i \]
Where:
The Capital Asset Pricing Model (CAPM) is a financial model used to determine the expected return on investment, considering the level of risk associated with that investment. It provides a framework for calculating the required rate of return based on the risk-free rate, the systematic risk of the investment (measured by beta), and the market risk premium.
The CAPM formula assumes that investors are rational and risk-averse, seeking to maximize their returns while minimizing risk exposure.
Let's assume the following values:
Using the formula to calculate the Expected Return (E(Ri)):
\[ E(R_i) = 2\% + [8\% - 2\%] \times 1.2 = 9.2\% \]
The expected return on the capital asset is 9.2%.
