Sunday, November 18, 2012

Some Important Concepts of Finance

Some of the important concepts of Finance (some overlaps):
  1. NPV: Net Present Value - If you could buy cash flows in the capital markets cheaper than you can generate them through your own operations and investments, you should do so. Net Present Value is a way of making sure that you engage in only those investments that cover their opportunity cost. 
  2. CAPM: Capital Asset Pricing Model : Beta: Only undiversifiable risk is priced 
  3. Effiicent Capital Markets / Efficient Market Hypothesis- there are no money machines
  4. Value Additivity
  5. Capital Structure and M&M (Modigliani Miller)
  6. Options Pricing Theory - replicating portfolios
  7. Risk / Return trade-off
  8. Diversification
  9. Dollar Cost Averaging
  10. Asset Allocation
  11. Random Walk Theory
  12. Optimal Portfolio - the efficient frontier

Useful Links:
Notes from Investopedia
  • The risk/return trade-off is the balance between the desire for the lowest possible risk and the highest possible return.
  • Higher risk equals greater possible return.
  • Diversification lowers the risk of your portfolio.
  • Dollar cost averaging is a technique by which, regardless of the share price, a fixed dollar amount is invested on a regular schedule.
  • Asset allocation divides assets among major categories in order to create diversification and balance the risk.
  • Random walk theory says that stocks take a random and unpredictable path.
  • Efficient Market Hypothesis (EMH) says it is impossible to beat the market because prices already incorporate and reflect all relevant information.
  • The concept of the optimal portfolio attempts to show how rational investors will maximize their returns for the level of risk that is acceptable to them.
  • Capital asset pricing model (CAPM) describes the relationship between risk and expected return and serves as a model for the pricing of risky securities.

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