Capital Asset Pricing Model, CAPM ((See Chapter 19 of the Vernimmen))

The CAPM is based on the assumption that investors act rationally and have at their disposal all relevant information on financial securities. CAPM is the universally used tool for valuing financial securities. CAPM states that all investors should hold the market portfolio, and the risk premium they will demand is proportional to market beta. According to CAPM, the expected return of an asset will then be a linear function of beta: Expected return of a financial security = risk-free rate + ? x (expected return of the market – risk-free rate)