APT

Question 1

single-factor model

Answer 1

A model of security returns that decomposes the sources of return variability into one sys- tematic economywide factor and firm-specific factors.

Question 2

multifactor model

Answer 2

Model of security returns positing that returns respond to several systematic risk factors as well as firm-specific influences.

Question 3

factor loading

Answer 3

Sensitivity of security returns to the realization of a systematic factor. Also called factor beta and factor sensitivity.

Question 4

factor beta

Answer 4

Sensitivity of security returns to the realization of a systematic factor. Also called factor loading and factor sensitivity.

Question 5

arbitrage pricing theory (APT)

Answer 5

An asset pricing theory that is derived from a factor model, using diversification and arbitrage arguments. The theory describes the relationship between expected return and factor exposure that follows from the absence of risk-free arbitrage opportunities.

Question 6

arbitrage

Answer 6

A zero-risk, zero-net investment strategy that still generates profits.

Question 7

Law of One Price

Answer 7

The rule stipulating that equivalent securities or bundles of securities must sell at equal prices to preclude arbitrage opportunities.

Question 8

risk arbitrage

Answer 8

Speculation on perceived security mispric- ing, often in connection with merger and acquisition targets.

Question 9

well-diversified portfolio

Answer 9

A portfolio spread out over many securities in such a way that the weight in any security is close to zero, resulting in negligible diversifi- able risk.

Question 10

factor portfolio

Answer 10

A well-diversified portfolio constructed to have a beta of 1.0 on one factor and a beta of 0 on any other factor.