What is the Capital Asset Pricing Model (CAPM) and how does it calculate the expected return on an investment?

What arbitrage pricing theory (APT) differs from CAPM — allows multiple systematic risk factors

APT considers multiple risk factors, unlike CAPM's single market risk factor

What Long-Term Capital Management's failure showed — even Nobel Prize-winning models can blow up

Nobel models can't always predict extreme market events

What the risk-free rate represents — return on a theoretically riskless investment (Treasury bills)

The risk-free rate is the return on investments with minimal risk, like Treasury bills

What the Markowitz mean-variance optimization does — finds the portfolio with minimum variance for a given return

Determines optimal asset allocation for desired return with minimal portfolio risk

What the Sharpe ratio measures — excess return per unit of risk: (R - Rf) / σ

Sharpe ratio: Excess return per standard deviation of portfolio returns

What the risk parity approach does — allocates based on risk contribution, not capital allocation

Risk parity distributes capital proportionally to each asset's risk contribution