From the course: Corporate Finance Foundations
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Capital asset pricing model (CAPM)
From the course: Corporate Finance Foundations
Capital asset pricing model (CAPM)
- We are now standing at the center of much of corporate finance, evaluating the trade-off between anticipated risk and expected return. Again, more anticipated risk means more expected return. At the center of corporate finance, we will see the capital asset pricing model. To this point, we've looked at all the pieces. We're now ready to look at the entire capital asset pricing model. Here it is, here's the capital asset pricing model in all its glory. We have discussed all of these components. Now we will tie them all together. Remember, the risk-free rate is the minimum return that we have to earn on any investment. Returns on investment in stocks of companies have to be higher than the risk-free rate. We call that difference the equity risk premium. Well, how much higher? Well, that depends on the risk associated with the investment. And remember, this is unavoidable risk or beta risk. Some risks can be avoided through diversification, but the beta risk cannot be avoided through…
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