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According to the capital asset pricing model (CAPM), where does an asset’s expected return come from?...

According to the capital asset pricing model (CAPM), where does an asset’s expected return come from? Please explain each component.

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Answer #1

Cost of capital using CAPM = Risk Free rate + Beta*(Market Return - Risk Free rate)

Risk free rate can be obtained from yield of the 10 - year US govt bond.Risk free rate is default free return.

Expected rate of Market can be obtained by taking average of 5 years of Return of S&P 500 stock returns. It is the market return or average stock returns over a period of time. In this case beta is 1.

Beta can be obtained from beta from similar company or industry.For a traded company the slope between excess stock returns over risk free rate and excess market returns over risk free rate.Beta represent the correlation of stocks with the market.Higher the beta higher is the risk.

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