Definition
The Capital Asset Pricing Model (CAPM) is a formula used to calculate the expected return on an investment based on its risk. It helps investors understand how much return they should expect for taking a certain level of risk compared to the market.
Example
For example, if the risk-free return is 5%, the market return is 10%, and a stock is riskier than the market, CAPM may estimate its expected return at around 12%. This means the investor is taking a higher risk to earn higher returns.
Caution
CAPM is based on assumptions and may not always reflect real market conditions. It should be used as a guide, not the only factor, when making investment decisions.