An arbitrage price model recommends buying more of Stock X anThe resulting effect should be
A) all prices should rise.
B) the returns on Y and Z should decline.
C) the return on X should decline.
D) the price of Y and Z should rise.

Question

Quizplus · Accepted Answer

If an arbitrage price model recommends buying more of Stock X, it means that the current price of Stock X is undervalued compared to its true value. This would result in an increase in demand for Stock X, which would cause its price to rise. However, since the model recommends buying more of Stock X, it would also mean selling stocks Y and Z to generate cash to buy more of Stock X. This would cause the prices of Y and Z to decline, and hence their returns would also decline. The return on Stock X should decline because as its price increases, the potential profit from future price increases decreases. Therefore, the correct answer is C.

An Arbitrage Price Model Recommends Buying More of Stock X