Rate of Return Calculator (Beta/CAPM)
Calculate your expected return using the Capital Asset Pricing Model
Understanding the Beta-Based Rate of Return
The Rate of Return Calculator Beta uses the Capital Asset Pricing Model (CAPM) to estimate the theoretically required rate of return for an asset. This model is a cornerstone of modern financial theory, linking the relationship between systematic risk and expected return for assets, particularly stocks.
Beta (β) measures a security's sensitivity to market movements. A beta of 1.0 indicates the asset moves perfectly in line with the market. A beta greater than 1.0 suggests higher volatility (and higher potential return), while a beta less than 1.0 suggests lower volatility.
If the current Risk-Free Rate (like a 10-year Treasury yield) is 4%, your stock has a Beta of 1.5, and the overall Market Return is expected to be 10%:
Return = 4% + 1.5 * (10% – 4%) = 13%
The CAPM Formula Explained
The calculation follows this specific mathematical structure:
Expected Return = Risk-Free Rate + Beta × (Market Return – Risk-Free Rate)
- Risk-Free Rate: The return on an investment with zero risk, typically represented by government bonds.
- Beta (β): A measure of the asset's risk relative to the market. High beta means high sensitivity to market swings.
- Market Risk Premium: The difference between the Market Return and the Risk-Free Rate (Rm – Rf). This represents the extra return investors demand for taking on market risk.
Why Beta Matters for Investors
Beta is essential for portfolio diversification. By combining assets with different betas, investors can tailor their portfolio's risk profile to their specific tolerance. If you are a conservative investor, you might look for assets with a beta lower than 1.0. If you are looking for aggressive growth, you might seek out high-beta stocks, understanding that they will likely drop more significantly during market downturns but outperform during bull markets.