Capital Asset Pricing Model



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How the parameters of CAPM like Rf, Rm, Beta been considered to calculate the cost of equity?

2 Answer(s)


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Used to calculate cost of equity from company's perspective and shareholder's return from investor's perspective.
Rf= Risk free return or the return on Govt securities like T-bills, municipal bonds etc
Rm= Market return
So, Rm-Rf= Risk premium
Beta for a company varies from time to time and is given on any stock website like money control

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The general idea behind CAPM is that investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of time and to the market premium (Rm-rf).