The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks. CAPM is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital.

CAPM (Capital Asset Pricing Model) takes into account the systematic risk as the unsystematic risk can be diversified. It creates a theoretical relationship between risk and rate of return from a portfolio.

CAPM formula

(ERm – Rf) = The market risk premium, which is calculated by subtracting the risk-free rate from the expected return of the investment account.