# Is the CAPM good after engineering

## Capital Asset Pricing Model (CAPM)

The English term Capital Asset Pricing Model, translated as a price model for capital goods or capital goods price model, describes an equilibrium model for the capital market, which expands portfolio theory to include a perspective. In particular, it is a question of which part of the overall risk of an investment object cannot be eliminated through risk spreading (diversification). There is an explanation for the risky investment opportunities in the capital market and evaluates them.

The **Capital Asset Pricing Model** or the CAPM was developed independently by William F. Sharpe, John Lintner and Jan Mossin in the 1960s and developed from the portfolio theory of Harry M. Markowitz and builds on it accordingly.

The theoretical capital market model uses a linear function to describe the expected return on a security using a linear function. This is the risk premium of a market portfolio, which characterizes the entirety of all circulating risky securities. The theory of the model states that the more a security reacts to decisive market fluctuations, the higher the expected return.

**Core and goal of the CAPM**

At the core of the CAPM, the model is the stock line. The linear dependency describes the expected return on an investment from just one risk factor, the so-called one-factor model. The aim of the model is the equilibrium prices for the individual risky investment options, here to derive the securities in the portfolio context under uncertainty with the risk decision.

**Formula of the CAPM**

The CAPM is followed by an expected return on an investment, for example with a share with the following formula:

Expected return = risk-free interest rate i + ß × (market return - risk-free interest rate).

The designations mean that i is the risk-free interest rate, such as for safe government bonds and ß is the beta factor, which indicates how decisive the share reacts to market changes on the stock exchange. The market rate of return is the rate of return that is realized on the capital market if the investments are widely distributed, as determined by the stock index, but only for past data.

The second part of the formula - ß × (market return - risk-free interest rate) is the risk premium and the difference (market return - risk-free interest rate) is the market risk premium.

### example

The expected return on the A-AG share should be calculated. The risk-free interest rate is 2%, the market return, which is determined using a stock index, is 6% and the ß-factor is 1.2.

The expected return on the A-AG share is calculated as follows: 0.02 + 1.2 × (0.06 - 0.02) = 0.02 + 0.048 = 0.068 = 6.8%.

The expected return on the A-AG share is thus 6.8%.

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