Capital Asset Pricing and Arbitrage Pricing Theory

These flashcards cover key concepts from the Capital Asset Pricing and Arbitrage Pricing Theory lecture, helping students understand essential terms and principles for their exam.

Capital Asset Pricing Model (CAPM)

A model that describes the relationship between systematic risk and expected return for assets, used for pricing risky securities.

Market Portfolio

A portfolio that contains all securities in the market, weighted by their market value, and lies on the efficient frontier.

Security Market Line (SML)

A graphical representation of the expected return-beta relationship defined by the CAPM.

Beta

A measure of an asset's sensitivity to market movements; reflects the volatility of an asset compared to the market.

Alpha

The excess return of an investment relative to the return predicted by the CAPM; can indicate an investment’s performance.

Efficient Frontier

A graphical representation of the set of optimal portfolios that offer the highest expected return for a defined level of risk.

Arbitrage Pricing Theory (APT)

A theory that suggests that asset returns are affected by multiple factors and that mispricing can create riskless profit opportunities.

Covariance

A measure of how much two random variables change together; in finance, it relates to how asset returns move in relation to each other.

Multifactor Models

Models that explain asset returns through several factors beyond just market risk; an extension of APT.

Risk Premium

The return in excess of the risk-free rate that investors require as compensation for the additional risk taken on by holding a risky asset.