Arbitrage Pricing Theory and Multifactor Models of Risk
I. Factor models are a tool that allow us to describe and quantify the dierent factors that
aect the rate of return on a security during any time period.
1. In the single factor,
Risk Aversion and Capital Allocation to Risky Assets
I. The process of constructing a portfolio can be viewed as a sequence of (1) selecting the
composition of ones portfolio of risky assets such as stocks and long-term bonds, and (2)
Optimal Risky Portfolios
I. Portfolios that are composed of only one stock face two sources of risk: (i) risk from the
general macroeconomic conditions such as the business cycle, interest rates, and exchange
rates, and (ii) rm-specic inuences s
Mutual Funds and Other Investment Companies
I. Investment companies are nancial intermediaries that collect funds from individual
investors and invest those funds in a potentially wide range of securities or other assets.
Each investor has a cla
I. We can use a single-factor security market to greatly simplify the Markowitz procedure.
1. The success of a portfolio selection rule depends on the quality of the inout list:
specically, the estimates of expected security returns
Learning about Risk and Return from the Historical Record
I. Interest rates and forecasts or their future values are among the most important inputs into
any investment decision.
1. If an investor expects rates to fall, they will choose longer-t
Toolkit Series Jan. 14, 2013
Booklet 5:.Euided Visits
Places are powerful tools to help connect us to the past. An adult returning to a
playground might be ooded with memories from childhood. A family's annual trip to a favorite
The Investment Environment
I. The material wealth of society can be divided into real and nancial assets.
1. Real assets are the land, buildings, machines, and knowledge used to produce goods
and services. They generate net income in the economy
The Ecient Market Hypothesis
I. The ecient market hypothesis (EMH) is the notion that stocks already reect all available
1. The evidence generally supports the idea that stock prices are unpredictable and
that new information causes
The Term Structure of Interest Rates
I. Bonds of dierent maturity tend to sell at dierent yields to maturity, a relationship summarized graphically
as a yield curve.
1. Yield curves may take on any number of shapes, including upward slopi
I. The option contract species the terms and conditions of the option.
1. A call (put) option gives its holder the right to purchase (sell) an asset for a specied price called the
exercise price or strike price on or befor
Bond Prices and Yields
I. A bond is a security that obligates the issuer to make specied payments to the bondholder on specied dates.
1. The bond indenture is the contract between bondholder and issuer that species the maturity date,
Asset Classes and Financial Instruments
I. The money market is a subsector of the debt securities market consisting of short-term
securities that are highly marketable. Most such securities are in high denominations, so
many investors access the
The Capital Asset Pricing Model
I. The capital asset pricing model (CAPM) is a set of predictions concerning equilibrium
expected returns on risky assets.
1. The CAPM was developed in 1964 by Sharpe, Lintner, and Mossin based on the
How Securities are Traded
I. To raise capital, rms may choose to oat (or sell) securities in the primary market, which
may then be resold in the secondary market.The two major types of primary stock issues
are initial public oers (IPOs) and seas