Exam 10: Arbitrage Pricing Theory and Multifactor Models of Risk and Return

Consider the multifactor model APT with three factors. Portfolio A has a beta of 0.8 on factor 1, a beta of 1.1 on factor 2, and a beta of 1.25 on factor 3. The risk premiums on the factor 1, factor 2, and factor 3 are 3%, 5%, and 2%, respectively. The risk-free rate of return is 3%. The expected return on portfolio A is __________ if no arbitrage opportunities exist.

There are three stocks: A, B, and C. You can either invest in these stocks or short sell them. There are three possible states of nature for economic growth in the upcoming year (each equally likely to occur); economic growth may be strong, moderate, or weak. The returns for the upcoming year on stocks A, B, and C for each of these states of nature are given below: State of Nature Moderate Weak Stock Strong Growth Growth Growth A 39\% 17\% -5\% B 30\% 15\% 0\% C 6\% 14\% 22\% If you invested in an equally-weighted portfolio of stocks A and B, your portfolio return would be ___________ if economic growth were moderate.

Suppose you are working with two factor portfolios, portfolio 1 and portfolio 2. The portfolios have expected returns of 15% and 6%, respectively. Based on this information, what would be the expected return on well-diversified portfolio A, if A has a beta of 0.80 on the first factor and 0.50 on the second factor? The risk-free rate is 3%.

Which of the following is(are) true regarding the APT?I) The security market line does not apply to the APT.II) More than one factor can be important in determining returns.III) Almost all individual securities satisfy the APT relationship.IV) It doesn't rely on the market portfolio that contains all assets.

Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 22%. The standard deviation on the factor portfolio is 14%. The beta of the well-diversified portfolio is approximately

An important difference between CAPM and APT is

In terms of the risk/return relationship in the APT,

Which of the following factors did Chen, Roll, and Ross include in their multifactor model?

An investor will take as large a position as possible when an equilibrium-price relationship is violated. This is an example of

Advantage(s) of the APT is (are)

Consider the multifactor APT with two factors. Stock A has an expected return of 17.6%, a beta of 1.75 on factor 1, and a beta of .86 on factor 2. The risk premium on the factor 1 portfolio is 3.2%. The risk-free rate of return is 5%. What is the risk-premium on factor 2 if no arbitrage opportunities exist?

Consider the single-factor APT. Stocks A and B have expected returns of 12% and 19%, respectively. The risk-free rate of return is 3%. Stock B has a beta of 1.2. If arbitrage opportunities are ruled out, stock A has a beta of

The term "arbitrage" refers to

An arbitrage opportunity exists if an investor can construct a __________ investment portfolio that will yield a sure profit.

The APT differs from the CAPM because the APT

Consider a single factor APT. Portfolio A has a beta of 2.0 and an expected return of 22%. Portfolio B has a beta of 1.5 and an expected return of 17%. The risk-free rate of return is 4%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio _______.

The feature of the APT that offers the greatest potential advantage over the CAPM is the