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CFA Level I · CFA Level I Exam · The Capital Asset Pricing Model, Market Model, and Other Factor-Based Equity Models

In an APT framework, if an asset's expected return is higher than the return implied by its factor sensitivities, arbitrageurs will most likely:

Arbitrageurs will buy the asset. Its expected return exceeds the return implied by its factor exposures, so it is underpriced. Buying raises the price and reduces the expected return until it equals the APT-implied return, removing the arbitrage opportunity.

  1. Asell the asset, pushing its price up until the mispricing disappears.
  2. Bbuy the asset, pushing its price up until the expected return falls to the model-implied level.Correct
  3. Chold the asset only if its unsystematic risk is zero.

Explanation

An expected return above the required return means the asset is underpriced. Arbitrageurs buy it, raising its price and lowering its expected return until it matches the APT-implied level. Selling would apply to an overpriced asset.

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