What does the Capital Asset Pricing Model (CAPM) primarily calculate?

The Capital Asset Pricing Model (CAPM) is a foundational financial model used to determine the expected return on an asset, specifically the cost of equity. It calculates this expected return by relating the risk of the asset in comparison to the market as a whole. The model incorporates the risk-free rate, the expected market return, and the asset's beta, which measures its sensitivity to overall market movements.

In practical terms, the formula for CAPM is expressed as:

Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate)

This indicates that the expected return not only considers a return that compensates for time value (risk-free rate) but also adds risk compensation in relation to how volatile the asset is compared to the overall market. This makes CAPM particularly valuable for investors evaluating potential investments or for companies in setting their equity cost in capital structure decisions.

The other options do not directly capture the essence of what CAPM is designed to do. While it relates to expected returns, they focus on different metrics that do not pertain specifically to calculating the cost of equity as CAPM does.