Capital Asset Pricing Model (CAPM)

Business.com / Finances / Last Modified: February 22, 2017

The capital asset pricing model functions with the understanding that investors need additional compensation when they invest in ...

The capital asset pricing model functions with the understanding that investors need additional compensation when they invest in riskier ventures. It also takes into consideration the time value of money. The formula for a CAPM calculator uses three pieces of information to calculate the necessary return; the risk free rate, the beta of the investment and the expected market return. The beta of a stock is the deviation that it has compared to the market. The return of the investment should be the risk free rate plus the result of the beta times the difference between the expected market return and the risk free rate.

Many financial planners use the capital asset's pricing model to decide whether the additional risk of a stock is worth adding to a client's portfolio. Sometimes the CAPM is used to judge the total portfolios risk and decide if changes need to the portfolio are necessary.

As you apply the CAPM model, consider the following:

  1. Know the capital asset pricing model definition so you can determine other capital investments besides stock.
  2. Use the capital asset pricing model formula to understand how diversification of asset's risk classification reduces risk.
  3. of the major advantages of CAPM is the fact that it provides a formula where financial decisions are based on a risk to reward ratio.

Look for capital asset pricing model calculator software for portfolio risk management

You can purchase software for CAPM calculation. The type of software you purchase varies with your need. Investment portfolio management, stock and option evaluation and business expenditures all come on different programs. Occasionally a program provides both portfolio management and individual investment analysis.

Get information that integrates the CAPM analysis with the modern portfolio theory

Many programs offer CAPM analysis but fail to do a practical integration of the asset into the portfolio. The more diversified the portfolio, the greater the reduction of the systematic risk. Unfortunately, diversification isn't enough so the capital asset pricing model formula filled in the blanks and finalized the theory. You can learn the use of the model to improve your business savvy and aid the client is choosing the right stock.
An Introduction to Investment Theory by William N. Goetzman is available online for free. It covers not only CAPM but other investment theory. Brokers benefit from the book Modern Investment Theory, which comes with software and tests on the investment theory and asset management.

Professionalize your brokerage business using CAPM analysis

Today's broker needs to be more innovative and know leg able to capture high dollar clients. The use of software reduces the workload and increases the attractiveness of the presentation. These factors allow you to handle more clients with ease and impress those that you already have.
  • All financial planners and brokers should purchase their own Capital Asset Pricing Model (CAPM) software for use with clients. Free downloads are intended for an individual's personal use.

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