CAPM Return Calculation Examples Help

CAPM Return Calculation Examples, Concept, Samples, Illustrations Help Online


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CAPM Return Calculation Examples Concept

The relationship between the required return and the systematic risk of an investment is established by capital asset pricing model.
There are two types of risk systematic risk and unsystematic risk. Systematic risk cannot be avoided as it is the risk created by the whole economy like risk of recession. It affects all investments. Unsystematic risk is the risk attached to a particular investment. Such risk can be neutralized by adding more investments to a portfolio. The formula of CAPM return is as follows
Required return = risk free rate + beta coefficient × equity risk premium
Risk free rate means an investment having zero risk.
Beta coefficient measures systematic risk.
Equity risk premium = broad market return – risk free rate

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CAPM Return Calculation Examples Explanation

Let’s take an example to understand the calculation of CAPM return model.
Example: A Corporation has a beta coefficient of 0.68. Estimate its cost of equity if the risk-free rate is 2% and return on the broad market index is 6%.
Solution: Under capital asset pricing model,
Cost of equity = risk free rate + beta coefficient × (broad market return – risk free rate)
Cost of equity = 2% + 0.68 × (6% – 2%) = 2% + 0.68 x 4% = 0.028 or 2.8%
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