A5

Question 1

Purpose of Single Factor Model

Answer 1

Focusing on individual risks rather than using a market proxy, we can account for each security’s unique sensitivity to each risk.

Question 2

Arbitrage definition

Answer 2

riskless profit (guaranteed) without the need to make a net investment (don’t need to contribute own money)

Question 3

Arbitrage SML

Answer 3

assumes αP is 0 (i.e. no arbitrage opportunities, because action of arbitrageurs will force alpha to 0. The B*E(R_M) is same equation as CAPM SML

Question 4

Big Advantage of APT

Answer 4

Big advantage is does not require an all inclusive portfolio (CAPM requires a true market portfolio and cannot be accurately tested as it requires this unobservable true market portfolio.

Question 5

Advantage of Treynor black model

Answer 5

T-B is more flexible than Arbitrage Pricing Theory because it reflects residual risk

Question 6

Arbitrage Pricing Theory does what?

Answer 6

calculates the expected return of a security