What does the Capital Asset Pricing Model (CAPM) help to calculate?

The Capital Asset Pricing Model (CAPM) is a financial model that helps to calculate the expected return on an investment based on its systematic risk, as measured by beta. The fundamental premise of CAPM is that investors need to be compensated for both the time value of money and the risk associated with the investment.

In this model, the expected return on an asset is determined by adding the risk-free rate to the product of the asset's beta and the market risk premium (the expected return of the market minus the risk-free rate). This relationship implies that CAPM specifically quantifies the expected return on equity by assessing how much risk the equity holder is bearing in comparison to the overall market.

This makes it a crucial tool for investors and financial analysts when evaluating the potential profitability of equity investments. Understanding CAPM enables one to make informed decisions about whether an equity investment is likely to meet the investor's required return based on its risk profile.

The other choices do not accurately reflect the primary function of CAPM. For example, total asset allocation relates to the distribution of assets across various investment categories and is not the focus of CAPM. Market capitalization measures the total market value of a company's outstanding shares, while the debt-to-equity ratio assesses a company's