CA Final · Advanced Financial Management · Portfolio Management
Which statement best describes the Arbitrage Pricing Theory (APT) of Stephen Ross as compared with the CAPM?
APT explains expected returns using sensitivities to several macroeconomic factors, each with its own risk premium, and relies on the absence of arbitrage. Unlike CAPM, it does not need the market portfolio to be identified or all investors to be mean-variance optimisers.
- AAPT explains expected returns through sensitivities to several macroeconomic factors and does not require identification of the market portfolioCorrect
- BAPT assumes expected return depends only on beta relative to the market portfolio
- CAPT requires all investors to hold the same market portfolio and be mean-variance optimisers
- DAPT states that unsystematic risk is rewarded with a risk premium
Explanation
APT models expected return as a linear function of multiple systematic factors, each with its own sensitivity and risk premium. It rests on no-arbitrage and does not need the market portfolio. The single-beta description is CAPM, not APT, and unsystematic risk is diversifiable and not rewarded.
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