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Audit the yield. Calculate the expected return of an asset based on its systematic risk (Beta) and market performance.
Step-by-step breakdown of the underlying equations.
Rm - RfRf + Beta × Market Risk PremiumAccording to CAPM, this asset should return 11.20% to compensate you for its systematic risk. With a beta of 1.2, the asset is more volatile than the overall market.
The Capital Asset Pricing Model (CAPM) establishes the mathematical relationship between systematic market risk (Beta) and the expected rate of return for risky assets. Widely utilized in corporate finance, cost of capital estimation (WACC), and portfolio performance benchmarking, CAPM establishes the hurdle rate required to compensate investors for bearing non-diversifiable market risk.
Worked Example:\nAssume an investor evaluates an individual growth equity with a Beta of 1.20 during an economic cycle where the 10-Year U.S. Treasury yield is 4.0% (R_f = 0.04) and the broader S&P 500 long-term expected annualized return is 10.0% (R_m = 0.10):\n• Equity Risk Premium: 10.0% − 4.0% = 6.0%\n• Systematic Risk Adjustment: 1.20 × 6.0% = 7.20%\n• Required Expected Return: 4.0% + 7.20% = 11.20%.\n• Interpretation: Because the security is 20% more volatile than the broad market, an investor must demand an annualized return of at least 11.20% to justify holding it.
Compare your asset's projected cash flow returns against the CAPM Expected Return hurdle rate. If your financial forecast projects a return greater than the CAPM output, the security generates positive risk-adjusted excess return (Alpha). If the projected return is lower, the security undercompensates you for its market volatility.
A Beta of 1.0 indicates that the asset moves in lockstep with the broad market index. A Beta > 1.0 (such as 1.35) signifies higher volatility and greater sensitivity to macroeconomic swings (common in tech and cyclical stocks). A Beta < 1.0 (such as 0.65) indicates defensive characteristics (common in consumer staples and regulated utilities).
In professional finance and equity research, the yield on 10-Year sovereign government bonds (such as the 10-Year U.S. Treasury Note or UK 10-Year Gilt) is standard because its maturity matches the multi-year holding horizon of common equity investments.
Historically in the United States, the equity risk premium over long horizons has averaged between 4.5% and 6.5% above risk-free Treasury bonds, according to annual long-run data compiled by NYU Stern and Ibbotson Associates.
Yes, though rare in public equities. An asset with a negative beta moves inversely to the general stock market. Gold, certain commodities, and inverse volatility exchange-traded instruments frequently display negative or near-zero betas, making them effective hedges.
CAPM assumes that markets are perfectly efficient, that investors can borrow and lend at the risk-free rate, and that volatility (Beta) is the sole measure of risk. Multi-factor models like the Fama-French 3-factor and 5-factor models expand CAPM by incorporating size, value, profitability, and investment factors.
Data verified: September 2026