CMA Final · Strategic Financial Management · Asset Pricing Theories
Under a single-factor Arbitrage Pricing Theory model, Rf is 5%. Portfolio A has a sensitivity of 1.0 to the factor and an expected return of 12%. The factor risk premium is 7%. Portfolio B has a sensitivity of 1.5. The expected return on B consistent with no arbitrage is:
The no-arbitrage expected return on B is 15.5%. Portfolio A confirms the factor premium of 7% over a 5% risk-free rate, so B with sensitivity 1.5 earns 5% plus 1.5 times 7%, which is 10.5%, totalling 15.5%.
- A15.5%Correct
- B17.0%
- C10.5%
- D12.0%
Explanation
Check A: 5% + 1.0 x 7% = 12%, consistent. For B: 5% + 1.5 x 7% = 5% + 10.5% = 15.5%. 17.0% wrongly adds 1.5 x 7% to A's 12% less nothing, i.e. 12% + 5%; 10.5% omits the risk-free rate.
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