Question 1

You have a 3 factor model to explain returns.Explain what a factor represents in the context of the APT? Each factor is multiplied by a beta.What do these represent and how do they relate to the actual return?

Accepted Answer

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Question 2

Suppose you hold a portfolio that consists of an investment of 50 per cent in an asset A and the remainder invested at the risk-free rate.What happens to the beta of the portfolio if the risk-free rate doubles?

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Question 3

What does the APT assume about trading costs? And why does that matter?

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Question 4

In recent paper, R.David McLean of the University of Alberta and Jeffrey Pontiff of Boston College look at the impact of academic papers on "market anomalies": ﬁnance papers that have successfully tried to ﬁnd new risk factors.They argue that investors should be reading these papers.In an eﬃcient market, what would be the result if investors indeed read these papers?

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Question 5

Explain the conceptual differences in the theoretical development of the CAPM and APT.

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Question 6

Suppose a new type of risk appears.It is systematic, uncorrelated with previous systematic risks, was not priced before, but can be measured by a single variable.You try to price it, and you use both the CAPM and the APT.Explain how this new risk makes its way into each of the approaches.

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Question 7

Suppose you have a portfolio that contains 2 securities.You are considering adding a third security. Now assume that none of these securities carries any unsystematic risk.What will happen to the total risk of the portfolio if you add the third security?

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Question 8

An investor is using the APT to calculate expected returns and make investment decisions.He has three years of data.The investor runs into a ﬁnance professor who offers to supply him with an additional three years of data free of charge.Why should the investor accept the offer?

Accepted Answer

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Quiz 11: Factor Models and the Arbitrage Pricing Theory