Can you please tell me about the capital asset pricing model of valuation?
Answer:
Investors must price their stocks relative to the asset class they are in, meaning that a stock will go down in value if its risk/reward ratio is to high relative to the others in the same class.
This leads to the formula:
r = R_f + beta ( K_m - R_f ) where
r is the expected return rate on a stock;
R_f is the rate of a "risk-free" investment, like some short term bond;
K_m is the return rate of the appropriate asset class.
Beta measures the volatility of the stock, relative to the market. You can think of the formula as predicting a stock price as a function of its risk beta: CAPM says that if you know a stock's beta then you know the value of r that investors expect it to have. Other Questions and Answers: