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explain the concept of the capital asset pricing model

explain the concept of the capital asset pricing model
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The capital asset pricing model (CAPM) is a single factor model used to find the required rate of return on an asset. It is given by the following equation:

Where, re = required rate of return on the asset

Beta of the asset measures the systematic risk (market risk)

rm = market return

The single factor is the market risk given by beta, which is undiversifiable.

The CAPM is based on the following assumptions:

  • Investors are rational and risk averse
  • Investors are all well diversified
  • Unlimited money can be borrowed and lent at risk-free rate
  • There are no transaction costs when buying and selling assets
  • Information is available to all the investors at the same time
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