The Capital Asset Pricing Model

Practical Value of the CAPM

1

Despite the drawbacks of the CAPM, it is a useful tool for evaluating the reasonableness of future expectations or to make comparisons between investments. 

2

The CAPM formula can be used to compare investments, especially those that operate in the same industry. It can provide an insight into whether the expected return for a stock is reasonable or not.

3

An investor can also use the CAPM to evaluate their portfolio or an individual stock, in relation to the whole market. They can assess whether investing in their portfolio is really advantageous or not.

4

For instance, if the market has an expected return of 10% with a standard deviation of 8%, this would be a better choice than investing in a portfolio with the same return but higher standard deviation.

Test your knowledge...

1. How much can you expect to earn from a cash investment?

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