What does the Capital Asset Pricing Model (CAPM) estimate?

• A. Re = Rf + Beta*(Rm - Rf) + Alpha
• B. Re = Rf - Beta*(Rm - Rf)
• C. Re = Rf + Beta*(Rm - Rf)
• D. Re = Rf + (Rm - Rf)

Answer: (C)

CAPM estimates the expected (or required) return for an asset based on its systematic risk relative to the market. In this model, the expected return on the asset equals the risk-free rate plus a risk premium that scales with how strongly the asset moves with the market. The risk premium is the market return minus the risk-free rate, multiplied by the asset’s beta. So the formula shows Re as Rf plus Beta times (Rm minus Rf).

This form is correct because it captures two essential ideas: the baseline return you’d get from a risk-free investment, and the extra return investors demand for bearing market risk, adjusted by how sensitive the asset is to market moves (its beta). The other options misstate this relationship: one adds an Alpha term that CAPM doesn’t use, another subtracts the risk premium, and the last omits beta (implying a specific level of market risk rather than the general risk-adjusted return CAPM describes).