Skip to content

FRM Part I · FRM Exam Part I · The Arbitrage Pricing Theory and Multifactor Models of Risk and Return

A well-diversified portfolio has exposures to two factors: beta of 1.2 to Factor 1 and 0.5 to Factor 2. The risk-free rate is 3%, the Factor 1 risk premium is 4%, and the Factor 2 risk premium is 6%. Using a two-factor APT, what is the portfolio's expected return?

The expected return is 10.8%. It equals the 3% risk-free rate plus 1.2 times 4% (4.8%) plus 0.5 times 6% (3.0%). The 7.8% figure wrongly leaves out the risk-free rate.

  1. A10.8%Correct
  2. B7.8%
  3. C9.0%
  4. D12.0%

Explanation

E(R) = 3% + 1.2×4% + 0.5×6% = 3% + 4.8% + 3.0% = 10.8%. Omitting the risk-free rate gives 7.8%, which is the common mistake.

Did you get it right without looking?

One question tells you little. A timed set on The Arbitrage Pricing Theory and Multifactor Models of Risk and Return shows your real accuracy, how long you take and where you lose marks.

Practise The Arbitrage Pricing Theory and Multifactor Models of Risk and ReturnFree diagnostic mock

More The Arbitrage Pricing Theory and Multifactor Models of Risk and Return questions