Apt And 3 Factor

Question 1

Differences to capm

Answer 1

Multiple combination of linear factors whereas capm just beta
More useful to investors-takes
Into account market as a whole

Question 2

Avoids capm assumptions

Answer 2

Investors can borrow/lend any amount of money at the risk free rate
Have homogenous expectations
No tax/transaction costs to buying/selling

Question 3

Criticism

Answer 3

No theoretical explanation where the factors come from

Subjective is smb and hml are convincing risk factors

Question 4

Criticism- size

Answer 4

Better for small companies as doesn’t include risk factors

Question 5

Criticism-predictability

Answer 5

Isn’t useful for predicting how companies will perform in future

Question 6

Assumptions

Answer 6

Capital markets are perfectly competitive

Investors prefer more wealth to less

Question 7

Apt 3 factor Formula

Answer 7

Return=risk free +(return 1 X Beta 1) + (return 2 x beta 2)

Question 8

Fama and French 3 factor formula

Answer 8

Return- risk free return= Beta [market return- risk free] +sSML + hHML + e(t)