QUESTIONS & VERIFIED ANSWERS|A+ GRADED|BRAND NEW
In respect to the CAPM model, define what is asserts
ANSWER
That the expected return of any asset is solely determined by it's exposure to the market
portfolio, with the risk exposure known as Beta
In respect to arbitrage pricing theory (APT) define what it asserts
ANSWER
That expected returns are determined by exposures to multiple factors that are linked to the
macroeconomy, with the risk factors known as factor betas
In respect to arbitrage pricing theory (APT), who provided the alternative theory
ANSWER
Steven Ross
Define arbitrage pricing theory
ANSWER
A type of multifactor model that measures the linear relationship between a financial asset
and multiple risk factors (i.e Indicies and Macroeconomic factors)
In respect to arbitrage pricing theory (APT), what does it assume in respect to arbitrage?
1
,ANSWER
No available arbitrage opportunities, and if one does exist, it will very quickly evaporate due
to the trading actions of market participants
In respect to arbitrage pricing theory (APT), what is the key idea of the model?
ANSWER
To model systematic risk at a more granular level
In respect to arbitrage pricing theory (APT), what are the key assumptions?
ANSWER
1. Market participants are seeking to maximise their profits
2. Markets are frictionless (no barriers to entry, taxes or transaction costs)
3. There are no arbitrage opportunities and if they do exist they will quickly evaporate away
In respect to arbitrage pricing theory (APT), what is one both challenge and benefit to the
APT model?
ANSWER
It does not define the multifactors to use, which offers flexibility but also means the APT may
not be the best fit.
In respect to arbitrage pricing theory (APT), what needs to be checked on a periodic basis?
ANSWER
The factor sensitivities (i.e Betas)
2
,In respect to arbitrage pricing theory (APT), while no defined factors are prescribed, what
did Chen and Roll propose in respect to the four factors that can be used within the model?
ANSWER
1. The spread between short-term and long-term interest rates
2. Expected vs unexpected inflation
3. Industrial production
4. The spread between low-risk and high-risk corporate bond yields
In respect to arbitrage pricing theory (APT), that is the core of the model?
ANSWER
To find a combination of granular risk factors, that more closely predict the return of a finan-
cial asset
In respect to arbitrage pricing theory (APT), it is deemed that an analyst would be wise to
______ a security whos market price drifts below the APT mode and potentially _____ a se-
curity which prices is higher than the APT mode
ANSWER
Buy, Short/Sell
In respect to arbitrage pricing theory (APT), what does it introduce due to it's logic?
ANSWER
Model risk and the need to periodically update model coefficients to ensure robustness
3
, In respect to arbitrage pricing theory (APT) and multifactor models, define what the first in-
put is
ANSWER
Expected return for the security, the model will then offer a series of adjustments that at-
tempt to capture known variables that would influence the securities return
In respect to arbitrage pricing theory (APT) and multifactor models, each factor requires a
sensitivity input, what is this know as?
ANSWER
the factor beta
In respect to arbitrage pricing theory (APT) and multifactor models, what does the error
term represent?
ANSWER
Firm-specific return that is otherwise unexplained by the model
In respect to arbitrage pricing theory (APT) and multifactor models and the error term, de-
fine some of the key sources of firm-specific risk which is represented by the error term
ANSWER
1. Factors that are correlated with the securities return but excluded from the model
2. Randomness and potentially irrational market behavior
3. Unexpected firm-specific risk (i.e labour strikes, tarrifs etc)
In respect to arbitrage pricing theory (APT) and multifactor models and the error term, what
is it's expected value?
4
In respect to the CAPM model, define what is asserts
ANSWER
That the expected return of any asset is solely determined by it's exposure to the market
portfolio, with the risk exposure known as Beta
In respect to arbitrage pricing theory (APT) define what it asserts
ANSWER
That expected returns are determined by exposures to multiple factors that are linked to the
macroeconomy, with the risk factors known as factor betas
In respect to arbitrage pricing theory (APT), who provided the alternative theory
ANSWER
Steven Ross
Define arbitrage pricing theory
ANSWER
A type of multifactor model that measures the linear relationship between a financial asset
and multiple risk factors (i.e Indicies and Macroeconomic factors)
In respect to arbitrage pricing theory (APT), what does it assume in respect to arbitrage?
1
,ANSWER
No available arbitrage opportunities, and if one does exist, it will very quickly evaporate due
to the trading actions of market participants
In respect to arbitrage pricing theory (APT), what is the key idea of the model?
ANSWER
To model systematic risk at a more granular level
In respect to arbitrage pricing theory (APT), what are the key assumptions?
ANSWER
1. Market participants are seeking to maximise their profits
2. Markets are frictionless (no barriers to entry, taxes or transaction costs)
3. There are no arbitrage opportunities and if they do exist they will quickly evaporate away
In respect to arbitrage pricing theory (APT), what is one both challenge and benefit to the
APT model?
ANSWER
It does not define the multifactors to use, which offers flexibility but also means the APT may
not be the best fit.
In respect to arbitrage pricing theory (APT), what needs to be checked on a periodic basis?
ANSWER
The factor sensitivities (i.e Betas)
2
,In respect to arbitrage pricing theory (APT), while no defined factors are prescribed, what
did Chen and Roll propose in respect to the four factors that can be used within the model?
ANSWER
1. The spread between short-term and long-term interest rates
2. Expected vs unexpected inflation
3. Industrial production
4. The spread between low-risk and high-risk corporate bond yields
In respect to arbitrage pricing theory (APT), that is the core of the model?
ANSWER
To find a combination of granular risk factors, that more closely predict the return of a finan-
cial asset
In respect to arbitrage pricing theory (APT), it is deemed that an analyst would be wise to
______ a security whos market price drifts below the APT mode and potentially _____ a se-
curity which prices is higher than the APT mode
ANSWER
Buy, Short/Sell
In respect to arbitrage pricing theory (APT), what does it introduce due to it's logic?
ANSWER
Model risk and the need to periodically update model coefficients to ensure robustness
3
, In respect to arbitrage pricing theory (APT) and multifactor models, define what the first in-
put is
ANSWER
Expected return for the security, the model will then offer a series of adjustments that at-
tempt to capture known variables that would influence the securities return
In respect to arbitrage pricing theory (APT) and multifactor models, each factor requires a
sensitivity input, what is this know as?
ANSWER
the factor beta
In respect to arbitrage pricing theory (APT) and multifactor models, what does the error
term represent?
ANSWER
Firm-specific return that is otherwise unexplained by the model
In respect to arbitrage pricing theory (APT) and multifactor models and the error term, de-
fine some of the key sources of firm-specific risk which is represented by the error term
ANSWER
1. Factors that are correlated with the securities return but excluded from the model
2. Randomness and potentially irrational market behavior
3. Unexpected firm-specific risk (i.e labour strikes, tarrifs etc)
In respect to arbitrage pricing theory (APT) and multifactor models and the error term, what
is it's expected value?
4
