The capital asset pricing model (CAPM) and the arbitrage pricing theory (APT) are two methods used to assess the risk of an investment compared to its potential rewards.
The CAPM bases the price of stock on the time value of money (risk-free rate of interest (rf)) and the stock's risk, or beta (b) and (rm) which is the overall stock market risk. APT does not regard market performance when it is calculated. Instead, it relates the expected return to fundamental factors. APT is more complicated to calculate compared to CAPM because more factors are involved.
CAPM uses the formula: expected rate of return (r) = rf +b (rm - rf). The formula for APT is: expected return = rf + b1 (factor 1) + b2 (factor 2) + b3 (factor 3). APT uses a beta (b) for each particular factor regarding the sensitivity of the stock price.
The CAPM is used to help investors calculate the expected return on particular investments. APT calculates the same thing, except it relies on multiple factors including macro factors and company-specific factors. This includes things such as interest rates, economic growth and consumer spending.
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