Capital Market Theory

Capital Market Theory is a framework that explains how financial markets operate, particularly focusing on how investors make decisions about risk and return. It suggests that investors seek to maximize returns while minimizing risk through diversification—spreading investments across different assets. The theory also outlines the relationship between risk and expected return, emphasizing that higher potential returns often come with higher risks. Key concepts include the efficient market hypothesis, which posits that all available information is reflected in asset prices, and the capital asset pricing model (CAPM), which helps determine expected investment returns based on systematic risk.