CA Final · Advanced Financial Management · Portfolio Management
Which of the following statements about Arbitrage Pricing Theory (APT) is correct?
The correct statement is that in a well-diversified portfolio unsystematic risk is eliminated, so only sensitivity to common factors is rewarded. APT does not need an efficient market portfolio and does not name the factors; those assumptions are wrongly attributed to it.
- AIn a well-diversified portfolio, unsystematic risk is diversified away, so only sensitivity to the common factors is pricedCorrect
- BAPT requires the market portfolio to be mean-variance efficient for the pricing relationship to hold
- CAPT prescribes the exact macroeconomic factors that must be used in the model
- DUnsystematic risk of individual securities earns a risk premium under APT
Explanation
APT assumes returns follow a factor structure and that arbitrage removes mispricing, so with diversification idiosyncratic risk vanishes and only factor betas earn premiums. The market-portfolio efficiency requirement belongs to CAPM. APT does not specify which factors to use; they are chosen empirically.
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