The Capital Asset Pricing Model (CAPM) is a sophisticated model that establishes a relationship between expected risk and expected return. It operates on the principle that investors require higher returns as compensation for higher risks.
The CAPM is a formula used to determine the expected return on an investment by accounting for both the risk-free rate of return and the risk premium.
The market-risk premium is the additional return over a risk-free rate demanded by investors to compensate for the risk of holding a market portfolio instead of risk-free assets.
The risk premium represents the difference between the expected rate of return on an investment and the risk-free rate of return (such as those on government bonds) over the same period. It accounts for the compensation investors require to bear the additional risk associated with investment.
