To develop the set of efficient portfolios, the one-factor model does not require the estimation of direct covariances between each security. Instead, it requires the estimate of the
A) variance for each security.
B) value of the factor.
C) riskfree return.
D) expected return for each security.

Question

Quizplus · Accepted Answer

The one-factor model assumes that the returns of all securities are linearly related to a single common factor, such as the market return. Therefore, the covariance between any two securities can be estimated as the product of their respective betas (sensitivities to the factor) and the variance of the factor.

To Develop the Set of Efficient Portfolios, the One-Factor Model