In this reading, we introduce factor theory and factor risk A key point is that it is not the exposure to an asset that is rewarded, but the exposure to the underlying factors The risk of these factors is being rewarded with risk premiums Several factor theories are introduced, including the capital asset pricing model (CAPM) and multifactor models For the exam, understand the key assumptions of the CAPM while recognizing the model’s limitations in a real-world setting, and be able to contrast the CAPM with the assumptions of multifactor models Through multifactor models, we introduce the concept of a stochastic discount factor, which is a random variable used in pricing an asset Finally, be familiar with the efficient market hypothesis, since it identifies areas of market inefficiencies that can be exploited through active management.