The full form of CAPM in accounting is Capital Asset Pricing Model.
Understanding the Capital Asset Pricing Model (CAPM)
The Capital Asset Pricing Model (CAPM) is a crucial tool in finance and accounting used to calculate the expected rate of return for an asset or investment. It is particularly useful for pricing individual securities, such as stocks.
According to the reference: "The capital asset pricing model (CAPM) calculates expected returns from an investment and can be used to determine prices for individual securities, such as stocks."
Key Components of CAPM
While the question primarily asks for the full form, understanding the model's basics provides valuable context. The CAPM formula is:
E(Ri) = Rf + βi(E(Rm) - Rf)
Where:
- E(Ri) = Expected return of the asset
- Rf = Risk-free rate of return
- βi = Beta of the asset
- E(Rm) = Expected return of the market
- (E(Rm) - Rf) = Market risk premium
Practical Applications of CAPM
- Investment Decisions: Helps investors determine if an investment's expected return is justified by its risk.
- Capital Budgeting: Companies use CAPM to evaluate the rate of return when deciding on investment projects.
- Valuation: Can be used to estimate the cost of equity, an important input for valuation models.
- Pricing Securities: Determines the appropriate price for an individual security.
Example
Let's say you are analyzing a stock with a beta of 1.5. The risk-free rate is 3%, and the expected market return is 10%. Using the CAPM formula:
E(Ri) = 3% + 1.5 (10% - 3%)
E(Ri) = 3% + 1.5 (7%)
E(Ri) = 3% + 10.5%
E(Ri) = 13.5%
The expected return for this stock, according to CAPM, is 13.5%.
