What is the main function of the capital asset pricing model (CAPM)?

The capital asset pricing model (CAPM) is primarily designed to establish a relationship between the expected return of an asset and its systematic risk, which is measured by the asset's beta. In essence, CAPM articulates that the expected return on an investment should be proportional to its risk in relation to the overall market. This relationship helps investors understand the trade-off between risk and return, enabling them to make informed decisions regarding portfolio management and asset allocation.

Through the formula, one can see that CAPM incorporates the risk-free rate, the expected market return, and the beta of the asset, which indicates how much the asset’s returns are expected to move with the market. This understanding is crucial for investors assessing whether an investment offers sufficient expected returns to compensate for its risk level.

The other choices are oriented toward different financial concepts. Predicting market trends based on historical data involves techniques like technical analysis, whereas assessing the risk of corporate bonds often includes measures such as credit ratings. Calculating the value of an equity option typically involves models like the Black-Scholes formula, which focuses on different parameters such as volatility and time to expiration.