What this calculator does
The capital asset pricing model says the return an investor should require is the risk-free rate plus compensation for the market risk taken. How much compensation depends on beta, which measures how strongly the stock moves with the market.
A beta of 1 means the stock moves with the market and earns the full market return. A beta of 0.5 earns only half the risk premium, and a beta of 1.8 earns 1.8 times it, pushing the required return from 9.00 to 13.0 per cent on a 5 per cent premium.
The formula
Subtract the risk-free rate from the expected market return to get the market risk premium. Multiply that by beta and add the risk-free rate back.
| Term | Meaning |
|---|---|
| Risk-free rate | The return on a government bond of appropriate maturity, taken as the baseline. |
| Beta | How much the stock moves relative to the market. Above 1 is more volatile, below 1 less. |
| Market risk premium | The extra return the market as a whole is expected to deliver over the risk-free rate. |
The inputs explained
| Field | What to enter |
|---|---|
| Risk-free rate (%) | The risk-free rate, usually a long-dated government bond yield. |
| Beta | The stock's beta. Published for listed companies, or estimated from comparable businesses. |
| Expected market return (%) | The expected return on the market as a whole. |
When to use it
Estimating a cost of equity
CAPM is the standard input to WACC and to any discounted cash flow valuation.
Comparing two investments
A stock offering less than its CAPM return is not compensating for the risk it carries.
Understanding what beta costs
Seeing the required return rise with beta makes the price of volatility explicit.
Worked examples
Every figure in the tables below is produced by this page’s own calculator at build time, so the numbers and the tool always agree. Select any row to load that scenario.
What return does each beta require?
The same market conditions applied to stocks of different volatility.
| Beta | Required return on equity | Risk premium for this stock |
|---|---|---|
| 0.5 | 6.50% | 2.50% |
| 1 | 9.00% | 5.00% |
| 1.2 | 10.0% | 6.00% |
| 1.8 | 13.0% | 9.00% |
Questions
What does beta actually measure?
How much a stock has historically moved in response to market moves. A beta of 1.5 means it has tended to move one and a half times as far as the market in both directions. It measures market-related volatility, not total risk.
Why does CAPM ignore company-specific risk?
Because the model assumes investors hold diversified portfolios, in which company-specific risk cancels out. Only the risk that cannot be diversified away, which is market risk, earns a return under this view.
Is CAPM reliable?
It is widely used and widely criticised. Empirical tests find the relationship between beta and returns weaker than the model predicts, and beta estimates are unstable. It remains the standard starting point rather than a definitive answer.
What if beta is negative?
A negative beta means the asset tends to move against the market, which makes it valuable as a hedge. CAPM then gives a required return below the risk-free rate, which is logically consistent but rare in practice.
For where this figure is used, see the WACC calculator. For a risk-adjusted view of actual returns, see the Sharpe ratio calculator.