This book evaluates the development of Modern Portfolio Theory (MPT) based on the Sharpe CAPM and Ross four-factor APT, underpinned by Modigliani and Miller’s “law of one price”. Today anybody with appropriate software and a reasonable financial education can model risky investment portfolios. But one lesson from the 2007 banking and 2010 euro crises is that computer driven models can be so complex that investors may not interpret their results correctly. Returning to first principles, we therefore explain why MPT is only a guide to action and program trading is no substitute for human judgement. Investors should always understand the models that underpin their analyses.

1. The Beta Factor

   Introduction

   1. Beta, Systemic Risk and the Characteristic Line
   2. The Mathematical Derivation of Beta
   3. The Security Market Line

Summary and Conclusions

Selected References

2. The Capital Asset Pricing Model (CAPM)

   Introduction

   1. The CAPM Assumptions
   2. The Mathematical Derivation of the CAPM
   3. The Relationship between the CAPM and SML
   4. Criticism of the CAPM

Summary and Conclusions

Selected References

3. Capital Budgeting, Capital Structure and the CAPM

   Introduction

   1. Capital Budgeting and the CAPM
   2. The Estimation of Project Betas
   3. Capital Gearing and the Beta Factor
   4. Capital Gearing and the CAPM
   5. Modigliani-Miller and the CAPM

Summary and Conclusions

Selected References

4. Arbitrage Pricing Theory and Beyond

   Introduction

   1. Portfolio Theory and the CAPM
   2. Arbitrage Pricing Theory (APT)

Summary and Conclusions

Selected References

5. Appendix 58