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Capital Asset Pricing Model (CAPM)

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The capital asset pricing model is used to determine a theoretically appropriate required rate of return of an asset.

It uses the asset's sensitivity to non-diversifiable or systemic risk — represented as Beta (β) — as well as the expected return of the market, the expected return of a "risk-free" asset and other premiums that are specific to the asset.

The equation for CAPM is:

Ke = Rf + Beta (market risk premium) + (other company-specific premiums)

Where Ke refers to the cost of equity.

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