An Introduction to Investment Theory

This hyper-text book introduces the foundations of investment decision-making. Beginning with portfolio theory and the tradeoff between risk and return, it shows how the definition of investor risk depends crucially upon diversification. It explains modern asset pricing models currently used to determine the expected rate of return on investments and finally it presents evidence about what information can be used for strategic investment advantage. The book is designed for use in a four-week teaching module for master’s students studying introductory Finance. It assumes some knowledge of statistics and a familiarity with the concepts of net present value. Please feel free to link to this text, but do not download or reproduce the material without my permission, since it is copyrighted.


Chapter I Capital Markets: Investment Performance
Chapter II Basics of Return and Risk: Efficient Frontier
Chapter III Preferences and Investor Choice
Chapter IV CAPM: The Portfolio Approach to Risk
Chapter V Understanding Security Market Line
Chapter VI Arbitrage Pricing Theory
Chapter VII Betas, Leverage, Discount Rate
Chapter VIII Information & Efficiency of Capital Markets
SUMMARY Short Summary of Chapters For Study

I wish to thank the students in my 1996 Financial Management class for working with the notes to this book in the development phase, Ken Gray for his invaluable programming assistance and Zika Abzuk for system adminstration. I wish to thank my colleagues N. Prabhala, Geert Rouwenhorst and Campbell Harvey for their useful suggestions. I wish to thank Ibbotson Associates for the use of their Encorr software in the preparation of figures for this text. All errors are the sole responsibility of the author.


© William N. Goetzmann

YALE School of Management