Podcast
Questions and Answers
What is the primary assumption of the Arbitrage Pricing Theory (APT)?
What is the primary assumption of the Arbitrage Pricing Theory (APT)?
- An asset's return is dependent on various macroeconomic and security-specific factors. (correct)
- An asset's return is dependent on the Capital Asset Pricing Model (CAPM).
- An asset's return is dependent on a single macroeconomic factor.
- An asset's return is dependent on the risk-free rate only.
According to the APT, what are the two things that can explain the expected return on a financial asset?
According to the APT, what are the two things that can explain the expected return on a financial asset?
- The risk-free rate and the Capital Asset Pricing Model (CAPM).
- The asset's expected return and the market return.
- The asset's beta and the market return.
- Macroeconomic and security-specific influences, and the asset's sensitivity to those influences. (correct)
Who developed the Arbitrage Pricing Theory (APT) in 1976?
Who developed the Arbitrage Pricing Theory (APT) in 1976?
- Harry Markowitz
- John Maynard Keynes
- Eugene Fama
- Stephen Ross (correct)
What is the formula for the Arbitrage Pricing Theory (APT)?
What is the formula for the Arbitrage Pricing Theory (APT)?
What are some examples of security-specific influences in the APT?
What are some examples of security-specific influences in the APT?
What is the purpose of analyzing the relationship between an asset and its common risk factors in the APT?
What is the purpose of analyzing the relationship between an asset and its common risk factors in the APT?
What is the APT an alternative to?
What is the APT an alternative to?
What does 'bj' represent in the APT formula?
What does 'bj' represent in the APT formula?
Study Notes
Arbitrage Pricing Theory (APT)
- APT is a method for estimating the price of an asset, assuming an asset's return is dependent on various factors.
- The theory was first created by Stephen Ross in 1976 to examine the influence of macroeconomic factors.
Factors Affecting Asset Return
- Macroeconomic factors
- Market factors
- Security–specific factors
APT Formula
- The APT formula is an alternative to the Capital Asset Pricing Model (CAPM).
- The formula is: E(rj) = rf + bj1RP1 + bj2RP2 + bj3RP3 + bj4RP4 +...+ bjnRPn
- Where:
- E(rj) = the asset's expected rate of return
- rf = the risk-free rate
- bj = the sensitivity of the asset's return to the particular factor
- RP = the risk premium associated with the particular factor
Security-Specific Influences
- There are an infinite number of security-specific influences for any given security, including:
- Inflation
- Production measures
- Investor confidence
- Exchange rates
- Market indices
- Changes in interest rates
- The analyst must decide which influences are relevant to the asset being analyzed.
Pricing
- Once the expected rate of return of an asset is derived from the APT theory, the correct price of the asset can be determined.
- APT can be applied to portfolios as well as individual securities.
- A portfolio can have exposure and sensitivities to certain kinds of risk.
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Description
Learn about the Arbitrage Pricing Theory (APT), a method for estimating asset prices, and its key factors, including macroeconomic, market, and security-specific influences.
