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Describe what the CAPM is, and illustrate how it can be used to estimate a stock’s...

Describe what the CAPM is, and illustrate how it can be used to estimate a stock’s required rate of return.

(Please Explain Thoroughly)

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Answer #1

CAPM model helps to identify the required rate of a project or a company.. This helps in identifying the required rate for calculating intrinsic value of firm. Here Capm required rate is dependent on Beta , market risk premium and risk free rate.
​​​​​​​CAPM introduced linear relationship of return with risk free rate and market return and introduced the concept of systematic risk given by beta which cannot be diversified away and deversifiable risk.
Proxy for risk free rate is T-bill rate of return for less than 1 years
Proxy of market return is the S&P 500 returns for past 1 year
Beta = Covariance of Historical and market return/Variance of the market
Required Rate using CAPM = Risk Free rate + Beta*(Market Return - Risk Free rate)

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