Investment and Risk Management 022-2023 Tutorial Arbitrage Pricing Theory and Multifactor Models Question 1

Investment and Risk Management 2022-2023
Tutorial 5 - Arbitrage Pricing Theory and Multifactor Models

Question 1

1. 
   Compare the assumptions of the arbitrage pricing theory (APT) with those of the capital asset pricing model (CAPM).
   
2. 
   Last year the return on Harry Company stock was 5 percent. The portion of the return on the stock not explained by a two-factor macroeconomic factor model was 3 percent. Using the data given below, calculate Harry Company stock’s expected return.
   

Macroeconomic Factor Model for Harry Company Stock

Variable	Actual Value (%)	Expected Value (%)	Stock’s Factor Sensitivity
Change in interest rate	2.0	0.0	–1.5
Growth in GDP	1.0	4.0	2.0

3. 
   Assume that the following one-factor model describes the expected return for portfolios:
   

E(R_p) = 0.10 + 0.12β_p,1
Also assume that all investors agree on the expected returns and factor sensitivity of the three highly diversified Portfolios A, B, and C given in the following table: