What is the Capital Asset Pricing Model, CAPM?

by Girl Banker 

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You cannot go to a corporate finance or asset management interview without knowing the CAPM.

The CAPM model shows that the return to equity is a positive function of risk: ​

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BBU (Blissful Books United) is the fictional book store created in my book To Become an Investment Banker.

• re(BBU) is the cost of equity to BBU or said differently, it is the return that shareholders in BBU expect as a result of holding BBU shares.
  
  
• r(f) is the risk free rate
  
  

o We can use the return on a 10-year US Government bond as a proxy for the risk-free rate, rf.
o US Government bond yields are relatively easy to get a hold of online. Some portals will even allow you to download historical data into Excel.
o The downgrading of the US Government rating from AAA to AA+ by Standard & Poor's rating agency makes the usual text book assumption that the US Government is risk free debatable.

• β(BBU) is a measure of how volatile BBU’s share price is relative to the average of the market as proxied by a domestic stock index, e.g. the S&P500 

o If BBU is less volatile than the market, on average, β(BBU) will be less than 1.
o If BBU is more volatile than the market, on average, β(BBU) will be more than 1.

• {r(m) – r(f)} is the difference between the expected market return and the risk free rate.

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What is WACC, the Weight Average Cost of Capital?
Where can you get the cost debt used to calculate WACC?

Who is Girl Banker® and how can she help you?