The capm states that expected return equals the risk

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determine whether the asset is undervalued, overvalued, or properly valued. The CAPM states that expected return equals the risk-free interest rate r f plus a risk premium that depends on beta and the market risk premium r m - r f Expected return = Risk free rate + beta(Market risk – Risk free rate) The basic idea behind the capital asset pricing model is that investors expect a reward for both waiting and worrying. The greater the worry, the greater the expected return. If you invest in a
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risk-free Treasury bill, you just receive the rate of interest. That's the reward for waiting. When you invest in risky stocks, you can expect an extra return or risk premium for worrying. The capital asset pricing model states that this risk premium is equal to the stock's beta times the market risk premium. The CAPM assumes that the stock market is dominated by well-diversified investors who are concerned only with market risk. That makes sense in a stock market where trading is dominated by large institutions and even small fry can diversify at very low cost. Reference Brigham, E. F., & Houston, J. F. (2012). Fundamentals of financial management . (seventh ed.). Manson,OH: Cengage Learning. McCracken, M. (2009). CAPM-The Capital Asset Pricing Model. Retrieved October 13, 2012, from Yahoo finance . (n.d.). Retrieved from finance.yahoo.com
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