Chapter 2  Ten Principles of Finance
List of Terms
1.
Return and Risk
 There is a positive relationship between risk and return.
The more
risk an investor is willing to accept, the higher the expected return must be.
2.
Mean reversion
 Reversion to the mean is the tendency for measures of performance
such as percentage rates of return to revert to their historical averages
3.
Efficient capital markets
 The stock market is brutally efficient, current prices reflect
all publicly available information and prices react completely, correctly and almost
instantaneously to incorporate the receipt of new information.
4.
Capital Asset Pricing Model
 A model that describes the relationship between risk and
expected return and that is used in the pricing of risky securities.
The general idea behind CAPM is that investors need to be compensated in two ways:
time value of money and risk. The time value of money is represented by the riskfree (rf)
rate in the formula and compensates the investors for placing money in any investment
over a period of time. The other half of the formula represents risk and calculates the
amount of compensation the investor needs for taking on additional risk. This is
calculated by taking a risk measure (beta) which compares the returns of the asset to the
market over a period of time and compares it to the market premium (Rmrf).
5.
Beta
 A measure of the volatility, or systematic risk, of a security or a portfolio in
comparison to the market as a whole. Also known as "beta coefficient".
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 Spring '07
 GRAY,GARYJOSEPHWOOLRIDGE,JOSEPH
 Capital Asset Pricing Model

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