Chapter 7 - Capital Asset Pricing and Arbitrage Pricing Theory Flashcards
Define Alpha
The abnormal rate or return on a security in excess of what would be predicted by an equilibrium model such as the CAPM.
Define Arbitrage
Creation of riskless profits made possible by relative mispricing among securities
Define Arbitrage Portfolio
A zero-net-investment, risk-free portfolio with a positive return.
Define Arbitrage Pricing Theory
A theory of risk-return relationships derived from no-arbitrage considerations in large capital markets.
Define Capital Asset Pricing Model (CAPM)
A model that relates the required rate of return on a security to its systematic risk as measured by beta.
Define Expected Return-Beta Relationship
Implication of the CAPM that security risk premiums (expected excess returns) will be proportional to beta.
Define Factor Portfolio
A well-diversified portfolio constructed to have a beta of 1 on one factor and beta of zero on any other factor.
Define Market Portfolio (M)
The portfolio for which each security is held in proportion to its total market value.
Define Multifactor Models
Models of security returns that respond to several systematic factors.
Define Mutual Fund Theorem
States that all investors desire the same portfolio of risky assets and can be satisfied by a single mutual fund composed of that portfolio.
Define Security Characteristic Line (SCL)
A plot of a security’s expected excess return over the risk-free rate as a function of the excess return on the market.
Define Security Market Line (SML)
Graphical representation of the expected return-beta relationship of the CAPM.
Define Well-Diversified Portfolio
A portfolio sufficiently diversified that non-systematic risk is negligible.
