Risk Free Rate & CAPM Calculator
Calculate Cost of Equity or Implied Risk-Free Rate
Calculate Expected Return (Ke)
Use this to find the Cost of Equity using the Risk-Free Rate.
Solve for Risk-Free Rate
Reverse the formula to find the implied Risk-Free Rate.
Understanding the Risk-Free Rate and CAPM
The Capital Asset Pricing Model (CAPM) is a financial model used to determine the expected return of an asset based on its systematic risk relative to the overall market. Central to this formula is the Risk-Free Rate, which represents the theoretical return of an investment with zero risk.
The CAPM Formula
- E(Ri): Expected Return of investment (Cost of Equity).
- Rf: Risk-Free Rate (typically the yield on 10-year government bonds).
- β (Beta): The sensitivity of the asset's returns to market returns.
- Rm: Expected Return of the Market.
- (Rm – Rf): Market Risk Premium.
What is the Risk-Free Rate?
In practice, the risk-free rate is approximated by the yield on long-term government securities, such as the 10-Year U.S. Treasury Note. Because the U.S. government is unlikely to default on its debt, these securities are considered "risk-free" in financial modeling. Investors use this rate as a baseline; any additional risk taken (like buying stocks) must offer a return higher than this rate.
Why Calculate the Implied Risk-Free Rate?
While the risk-free rate is usually an input derived from bond markets, analysts sometimes need to "back-solve" for the rate implied by current market valuations. If you know the expected return of a stock (perhaps from a Dividend Discount Model), its Beta, and the Market Return, you can determine what risk-free rate the market is currently pricing in using the reverse calculation provided in the tool above.
How Beta Affects the Calculation
Beta measures volatility. A Beta of 1.0 means the stock moves in sync with the market. A Beta greater than 1.0 implies higher volatility (and thus higher expected return required), while a Beta less than 1.0 implies the asset is more stable than the market.