ABSTRACT
This chapter looks at the key original building blocks of Modern Finance Theory as they are still taught at many universities. Modern Finance and Modern Portfolio Theory would not be conceivable without the revolution of economics by the theory of rational expectations. Another important pillar of Modern Finance Theory is the theory of option pricing. Options have existed long before Modern Finance Theory. Then, buyers and sellers of options used common sense and their gut feelings to agree on a price that allowed the exchange to take place. The dissemination of the Black-Scholes-Formula casts an illuminating light on the academic establishment and the relationship between Modern Finance and the financial industry. In the Black-Scholes Formula the relationship between the price and the parameters of an option corresponds to that of the binomial model. It could be suspected that the compact model of Black-Scholes would have replaced entirely the complex binomial model with many periods.
