Correct Answer:
B. Return
Correct Answer: Return
The Capital Asset Pricing Model (CAPM) is a financial model used to estimate the expected rate of return on an investment. It helps investors determine the return they should expect based on the investment's systematic risk (Beta) relative to the overall market.
CAPM Formula
Expected Return = Risk-Free Rate + Beta × (Market Return − Risk-Free Rate)
Components of the Formula
- Risk-Free Rate (Rf): The return on a risk-free investment, such as a government treasury security.
- Beta (β): Measures the investment's systematic risk compared to the overall market.
- Market Risk Premium: The difference between the expected market return and the risk-free rate.
Why the Other Options Are Incorrect
- Risk: CAPM does not calculate risk; it uses Beta as an input representing systematic risk.
- Return: Correct Answer. CAPM estimates the expected return required for an investment.
- Risk and Return: Incorrect. CAPM estimates only the expected return while incorporating risk as an input variable.
- None of the above: Incorrect because CAPM is specifically designed to calculate expected return.
Exam Tip: For PPSC, FPSC, NTS, PMS, and finance-related examinations, remember that CAPM is used to estimate the expected return on an investment based on its systematic risk (Beta). It does not calculate the risk itself.