Foundational Finance Theories
Explain foundational finance theories
Foundational finance theories provide the framework for understanding how financial markets operate, how assets are priced, and how decisions are made in corporate finance and investment management. Here are explanations of some key foundational finance theories:
- Efficient Market Hypothesis (EMH):
- EMH posits that financial markets efficiently reflect all available information, meaning that asset prices instantly adjust to new information as it becomes available. This theory suggests that it is impossible to consistently outperform the market through stock picking or market timing.
- Capital Asset Pricing Model (CAPM):
- CAPM is used to determine the expected return on an asset based on its risk as measured by beta (systematic risk) and the risk-free rate of return. It states that investors should be compensated for the time value of money and the risk they take on by investing in an asset.
- Modern Portfolio Theory (MPT):
- MPT emphasizes the importance of diversification in achieving optimal portfolios. It suggests that investors can construct portfolios that maximize expected returns for a given level of risk or minimize risk for a given level of return…
Foundational finance theories provide the framework for understanding how financial markets operate, how assets are priced, and how decisions are made in corporate finance and investment management. Here are explanations of some key foundational finance theories:
- Efficient Market Hypothesis (EMH):
- EMH posits that financial markets efficiently reflect all available information, meaning that asset prices instantly adjust to new information as it becomes available. This theory suggests that it is impossible to consistently outperform the market through stock picking or market timing.
- Capital Asset Pricing Model (CAPM):
- CAPM is used to determine the expected return on an asset based on its risk as measured by beta (systematic risk) and the risk-free rate of return. It states that investors should be compensated for the time value of money and the risk they take on by investing in an asset.
- Modern Portfolio Theory (MPT):
- MPT emphasizes the importance of diversification in achieving optimal portfolios. It suggests that investors can construct portfolios that maximize expected returns for a given level of risk or minimize risk for a given level of return…
