function calculateExpectedReturn() {
// Get input values
var rfInput = document.getElementById('riskFreeRate').value;
var betaInput = document.getElementById('betaValue').value;
var rmInput = document.getElementById('marketReturn').value;
// Validation
if (rfInput === "" || betaInput === "" || rmInput === "") {
alert("Please fill in all fields (Risk-Free Rate, Beta, and Market Return).");
return;
}
var rf = parseFloat(rfInput);
var beta = parseFloat(betaInput);
var rm = parseFloat(rmInput);
if (isNaN(rf) || isNaN(beta) || isNaN(rm)) {
alert("Please enter valid numerical values.");
return;
}
// Logic: CAPM Formula
// E(Ri) = Rf + Beta * (Rm – Rf)
var marketRiskPremium = rm – rf;
var assetRiskPremium = beta * marketRiskPremium;
var expectedReturn = rf + assetRiskPremium;
// Update DOM
document.getElementById('marketRiskPremium').innerHTML = marketRiskPremium.toFixed(2) + "%";
document.getElementById('assetRiskPremium').innerHTML = assetRiskPremium.toFixed(2) + "%";
document.getElementById('expectedReturnResult').innerHTML = expectedReturn.toFixed(2) + "%";
// Show results
document.getElementById('resultContainer').style.display = "block";
}
function resetCalculator() {
document.getElementById('riskFreeRate').value = "";
document.getElementById('betaValue').value = "";
document.getElementById('marketReturn').value = "";
document.getElementById('resultContainer').style.display = "none";
}
Understanding Expected Rate of Return with Beta
The Expected Rate of Return Calculator is designed to help investors estimate the potential profitability of an investment based on its systematic risk relative to the overall market. This tool utilizes the Capital Asset Pricing Model (CAPM), a cornerstone of modern financial theory.
The CAPM Formula
The calculation performed by this tool is based on the following standard formula:
E(Ri) = Rf + β * (Rm – Rf)
Where:
E(Ri): Expected Rate of Return on the asset.
Rf: Risk-Free Rate (usually the yield on 10-year government bonds).
β (Beta): A measure of the volatility (systematic risk) of the asset compared to the market.
Rm: Expected Return of the Market (often based on S&P 500 historical averages).
Analyzing the Inputs
To use this calculator effectively, it is important to understand where to find the input data:
1. Risk-Free Rate (Rf)
This represents the return of an investment with zero risk. In practice, investors often use the yield on the 10-Year U.S. Treasury Note. As of typical market conditions, this might range between 2% and 5%.
2. Beta (β)
Beta measures how much a stock's price moves compared to the market.
Beta = 1.0: The asset moves exactly in sync with the market.
Beta > 1.0: The asset is more volatile than the market (higher risk, higher expected return).
Beta < 1.0: The asset is less volatile than the market (lower risk, lower expected return).
You can find the Beta for most public companies on financial news websites.
3. Expected Market Return (Rm)
This is the average return expected from the broader stock market. Historically, the S&P 500 has returned approximately 8% to 10% annually over long periods.
Example Calculation
Let's say you are analyzing a technology stock with the following metrics:
Risk-Free Rate: 4.0%
Beta: 1.5 (High volatility)
Market Return: 10.0%
First, we calculate the Market Risk Premium: 10.0% – 4.0% = 6.0%.
Next, we adjust for the asset's risk: 1.5 * 6.0% = 9.0%.
Finally, add the Risk-Free Rate: 4.0% + 9.0% = 13.0%.
This means that to compensate for the risk of holding this volatile stock, an investor should expect a 13.0% annual return.
Why is this Important?
Using the Beta-based Expected Rate of Return helps investors decide if a stock is worth the risk. If your fundamental analysis suggests a stock will return 15%, but the CAPM calculation (based on its risk profile) says you should only expect 13%, the stock might be undervalued or "alpha" generating. Conversely, if the CAPM requires 13% but the stock is likely to only grow 5%, it may be a poor investment choice.