In terms of the risk/return relationship in the APT,
A) only factor risk commands a risk premium in market equilibrium.
B) only systematic risk is related to expected returns.
C) only nonsystematic risk is related to expected returns.
D) only factor risk commands a risk premium in market equilibrium, and only systematic risk is related to expected returns.
E) only factor risk commands a risk premium in market equilibrium, and only nonsystematic risk is related to expected returns.

Question

Quizplus · Accepted Answer

The Arbitrage Pricing Theory (APT) posits that only factor risks, which are systematic, command a risk premium in market equilibrium. This is because systematic risks affect the entire market and cannot be diversified away, whereas nonsystematic risks, which are specific to individual securities, can be mitigated through diversification.

In Terms of the Risk/return Relationship in the APT