What does the capital asset pricing model (CAPM) help investors understand?

The capital asset pricing model (CAPM) is a foundational concept in finance that helps investors understand the relationship between the expected return of an asset and its systematic risk, as measured by beta. Essentially, CAPM posits that the expected return on an investment is proportional to its risk relative to the overall market. This relationship provides a way for investors to assess whether an asset is a worthwhile investment based on its risk-adjusted return.

Through this model, investors can determine the expected return for an investment given its risk level compared to the market, which aids in making informed investment decisions. By calculating the expected return, investors can also evaluate whether they are being adequately compensated for the risk they are taking on, which is a critical aspect of investment strategy.

Options that focus on historical performance, timing of transactions, or the impact of dividends do not encapsulate the core function of CAPM, which explicitly centers on risk and return dynamics rather than operational or historical analysis of investments.