The capital asset pricing model (CAPM) assesses the relationship between expected return and the expected volatility (systematic risk, or violence of movement) of stocks or other assets. CAPM use is widespread for pricing risky securities. It enables the calculation of expected returns for assets given the risk of those assets and generating costs of capital.
The formula is as follows:
R(e) = Rf + ? (R(m) – Rf)
R(e) = Expected return or the cost of capital (usually annual if Rf and R(m) are also annual assumptions)
Rf = the “risk free rate” of investing. Commonly the annual return or yield of a benchmark bond
? = beta: a measurement of the expected volatility or systematic risk of an investment versus the volatility of the market as a whole
R(m) = the expected annual return of the market