What return should you require for the risk you're taking?
Required return = risk-free rate + beta × equity risk premium. This is the Security Market Line — the line that says how much extra return you should demand for each unit of systematic risk.
Built and reviewed by Stephen Omukoko Okoth
Mathematical Economist · ex-Morgan Stanley FI · Equilar
Inputs
The three numbers
Verdict
10.00% required return.
4.5% risk-free + 1.00 × 5.5% premium.
If the asset's expected return is above this number, CAPM says it's worth the risk; below, you're being underpaid for what you're carrying.
Result
The decomposition
Required return
10.00%
Risk-free component
4.5%
Risk premium component
5.50%
β × ERP
Beta interpretation
Market
Security Market Line
Required return as a function of beta
The dot marks your input. Above the line = positive alpha (asset's expected return exceeds CAPM). Below = negative alpha.
Common questions
What is CAPM?
Capital Asset Pricing Model: required return = risk-free rate + beta × equity risk premium. It's the textbook model for the return an investor should require to hold a risky asset, given how much that asset moves with the market.
What is beta?
How a stock moves relative to the market. Beta of 1.0 = moves with the market. Beta of 1.5 = moves 50% more than the market. Beta of 0.5 = half as volatile. Negative beta = inverse to the market (rare; gold is a partial example).
What's the equity risk premium?
Long-run excess return of stocks over the risk-free rate. Common defaults: 5-6% for the US, slightly higher for emerging markets reflecting compensation for additional risk. The number is famously hard to pin down — Damodaran updates an estimate annually.
Is CAPM actually used?
Yes, ubiquitously, despite well-documented empirical weaknesses. Corporate finance teams use it for cost-of-equity in DCF models. Academics use multi-factor models (Fama-French) instead. For quick estimates, CAPM is the lingua franca.