Calculate Expected Stock Return with CAPM: Example & Formula

Using the Capital Asset Pricing Model (CAPM), we can calculate the expected return on a stock. CAPM states the relationship between the risk of an asset and its expected return. The formula for CAPM is:

E(Ri) = Rf + [E(RM) - Rf] x Bi

Where:

• E(Ri) is the expected return on the stock
• Rf is the risk-free rate
• E(RM) is the expected return on the market
• Bi is the beta of the stock

Example:

A stock has a beta of 1.25, the expected return on the market is 14%, and the risk-free rate is 5.2%. Using this information, we can calculate the expected return on the stock:

E(Ri) = 5.2% + [14% - 5.2%] x 1.25

E(Ri) = 5.2% + 9.8% x 1.25

E(Ri) = 5.2% + 12.25%

E(Ri) = 17.45%

Therefore, the expected return on this stock is 17.45%.