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Definition: A model that allows investors to price securities, such as stocks, based on the risk-free rate, market returns, and the security's volatility. The equation is characterized as:
ERk = rf + Bk (ERp - rf), where:
ERk is the expected return on the stock for the year
rf is the risk free rate of return
Bk is the beta of stock k
ERp is the expected return on the market portfolio (typically the S&P500)
StockJargon Advice: As long as you believe that beta is an accurate portrayal of a stock's risk relative to the market, CAPM is a great way to price securities. Many analysts use it to calculate a stock's cost of equity.
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