The 10 principles of finance

As technology, policy, and geopolitical developments roil the finance industry, it’s a good time to revisit the fundamentals.

In their 2025 book, “Principles of Finance,” authors Zvi Bodie, Robert C. Merton, and Richard T. Thakor present the 10 principles of finance, which they describe as “a foundation of core concepts that underlie all of finance and are applicable to the entire financial system, regardless of time and place.” (Merton, a Nobel laureate in economics, is a professor of finance at MIT Sloan.)

The 10 Principles of Finance

1. A dollar today is not worth the same as a dollar tomorrow. This principle embodies a crucial concept in finance, the time value of money, which states that, at a positive interest rate, a sum of money will grow in value over time.
2. Equivalent assets that can be freely bought and sold will have the same market price. The law of one price is a statement about the price of one asset relative to the price of another right now; it tells us that if the current price of GM stock on the New York Stock Exchange is $54 per share, we can be reasonably sure that its price in London is the same, $54.
3. There is no such thing as a free lunch in finance; everything has a cost. If some financial transaction seems too good to be true, it is almost certain to not be true.
4. Every model is an incomplete, simplified description of a complex reality. To determine the best model … consider three criteria: what to include in the model, who will be using the model, and what the model will be used for.
5. The best estimate of an asset’s value is usually its market price, which incorporates valuable information to guide the allocation of resources and risks. The key idea underlying all valuation procedures is that, to estimate how much an asset is worth, you must use information about one or more comparable assets whose market prices you know.
6. Risk is fundamental to financial analysis and must be explicitly considered in all financial decisions. And this risk must be measured and managed to successfully accomplish specific financial goals.
7. There is a trade-off between risk and expected return. The theory of finance assumes that people will avoid risk unless they are compensated for bearing it. The compensation takes the form of expected returns that are greater than the return that can be earned on a risk-free asset.
8. Flexibility in financial decisions has value, and the greater the uncertainty, the greater the value. Flexibility is valuable because it can reduce the risk that is inherent in financial decisions. Financial contracts known as options allow the holder the ability to make decisions in the future once outcomes are known. By embedding flexibility into them, options allow an analysis of uncertainty and risk in financial decisions.
9. Transparency, verification, and trust are all important to the proper functioning of the financial system. Transparency means that all parties to a financial transaction have available to them all the relevant information they need to make an informed decision. Verification means that information provided to the customer has been examined and certified by a third party to be true. Trust is the belief that someone or something is reliable, truthful, and capable.
10. The basic functions of a financial system are essentially the same in all economies all over the world, past, present, and future, but the institutions used to perform these functions differ across geopolitical borders and over time. The roles played by families, governments, and private sector institutions (such as banks and securities markets) in financing economic activities vary considerably between countries. What’s more, these roles change over time.  

More about “Principles of Finance”

Excerpted from “Principles of Finance” by Zvi Bodie, Robert C. Merton, and Richard T. Thakor, published by Cambridge University Press. Copyright © Zvi Bodie, Robert C. Merton, and Richard T. Thakor 2025. Reproduced with the permission of the licensor through PLSclear.

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Zvi Bodie is professor emeritus at Boston University, where he was a professor of management. He also served on the finance faculty at Harvard Business School (1992 – 1994) and MIT Sloan (2008 – 2009). Among his many published books is the bestselling textbook “Investments,” co-authored with Alex Kane and Alan Marcus.

Robert C. Merton is a professor of finance at MIT Sloan and a university professor emeritus at Harvard University. Merton received the Alfred Nobel Memorial Prize in Economic Sciences in 1997 for a new method to determine the value of derivatives. Merton’s current research focuses on life-cycle investing and retirement funding solutions; measuring and monitoring macrofinancial systemic risk; and financial innovation and the dynamics of financial institutional change.

Richard T. Thakor is an associate professor of finance at the University of Minnesota’s Carlson School of Management and a research affiliate at the MIT Laboratory for Financial Engineering. He has published numerous academic articles in top economics, management, and finance journals and has won multiple teaching awards.