The key principles of asset pricing are:
1. Risk and return trade-off: Investors require higher returns for taking on more risk.
2. Time value of money: Money received today is worth more than the same amount received in the future.
3. Diversification: Investors can reduce risk by investing in a portfolio of assets that are not perfectly correlated.
4. Efficient Market Hypothesis: Markets are highly efficient and reflect all available information, making it difficult for investors to outperform the market.
These principles can be used to evaluate investment opportunities by:
1. Determining the expected return of the investment and comparing it to the risk involved. If the return is not commensurate with the risk, the investment may not be worth pursuing.
2. Using discounted cash flow analysis to determine the present value of expected cash flows from the investment.
3. Creating a portfolio of assets that are not perfectly correlated to spread out risk.
4. Conducting research and analysis to identify undervalued or overvalued assets in the market, and taking advantage of them.
