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What is capital asset pricing model?

 

What is capital asset pricing model?

 

Capital asset pricing model (CAPM) is a mathematical model used to price risky assets, like stocks, through a relationship between risk associated with such assets and the return that could be expected by the buyer of that asset. The basic idea behind CAPM is that a buyer of a risky asset should be compensated by the risk he / she is taking. This compensation is done through two ways -time value of money, and the risk. Time value of money is defined by the risk-free return that the investor could get if the same amount of money is invested in a risk-free security, like government bonds, over the same period of time for which he she is investing in a risky asset. Here, risk is measured by an element called beta which is the extra amount of money that the investor could get for taking on additional risks.

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