The capital asset pricing model is a theoretical model that attempts to explain the pricing that should be assigned to an asset. The model focuses on the relationship between systematic risk and the expected return on assets, where investors must be compensated for the time value of their money and the amount of risk they are taking on. The time value of money is derived from a risk-free rate, which is assumed to be the current rate on a U.S. government security. Risk is derived from the beta of a stock, which is based on its price volatility.
The model is primarily directed at the pricing for equity securities, as well as the development of a corporate cost of capital. The cost of capital outcome can then be used to decide whether the return on investment of a prospective capital investment will generate a return for the organization.