The equation for the Capital Asset Pricing Model (CAPM) is as follows:
r = rf + β (rm – rf)
- r is the expected return on the asset
- rf is the risk-free rate of return (such as the yield on a government bond)
- β is the asset’s beta, which measures the asset’s volatility or sensitivity to market movements
- rm is the expected market return
The equation states that the expected return on an asset is equal to the risk-free rate of return plus a premium that compensates for the risk of the asset, which is determined by the asset’s beta and the difference between the expected market return and the risk-free rate.
In other words, the equation implies that an investor can earn a higher expected return by investing in an asset that is riskier (i.e., has a higher beta) and by taking on more market risk (i.e., investing in an asset with higher expected market returns).