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Chapter 2: Q31I. (page 228)

The APT itself does not provide information on the factors that one might expect to determine risk premiums. How should researchers decide which factors to investigate?

Is industrial production a reasonable factor to test for a risk premium? Why or why not?

Short Answer

Expert verified

Researchers should investigate factors of uncertainty because Industrial production indicates changes in business cycle that correlate with uncertainties

Step by step solution

01

Definition

The APT (Arbitrage Pricing Theory) predicts the price of an asset while correlating it with many sources of uncertainty known as risk factors.

02

Solution

In the given scenario, researchers must investigate those factors of uncertainty such as GDP, Inflation rate, interest rate.

Industrial production indeed is highly correlated with uncertainties related to investment and consumption opportunities. Since it is a good indicator of changes in the business cycle, it can be a reasonable factor to test a risk premium.

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Most popular questions from this chapter

A zero-investment well-diversified portfolio with a positive alpha could arise if:

a. The expected return of the portfolio equals zero.

b. The capital market line is tangent to the opportunity set.

c. The law of one price remains un-violated.

d. A risk-free arbitrage opportunity exists.

Jeffrey Bruner, CFA, uses the capital asset pricing model (CAPM) to help identify mispriced securities. A consultant suggests Bruner use arbitrage pricing theory (APT) instead. In comparing CAPM and APT, the consultant made the following arguments:

a. Both the CAPM and APT require a mean-variance efficient market portfolio.

b. The CAPM assumes that one specific factor explains security returns but APT does not.

State whether each of the consultant’s arguments is correct or incorrect. Indicate, for each incorrect argument, why the argument is incorrect

Kaskin, Inc., stock has a beta of 1.2 and Quinn, Inc., stock has a beta of .6. Which of the following statements is most accurate?

a. The expected rate of return will be higher for the stock of Kaskin, Inc., than that of

Quinn, Inc.

b. The stock of Kaskin, Inc., has more total risk than Quinn, Inc.

c. The stock of Quinn, Inc., has more systematic risk than that of Kaskin, Inc.

Growth and value can be defined in several ways. Growth usually conveys the idea of a portfolio emphasizing or including only companies believed to possess above-average future rates of per-share earnings growth. Low current yield, high price-to-book ratios, and high price-to-earnings ratios are typical characteristics of such portfolios. Value usually conveys the idea of portfolios emphasizing or including only issues currently showing low price-to-book ratios, low price-to-earnings ratios, above-average levels of dividend yield, and market prices believed to be below the issues’ intrinsic values.

a. Identify and provide reasons why, over an extended period of time, value-stock investing might outperform growth-stock investing.

b. Explain why the outcome suggested in ( a ) should not be possible in a market widely regarded as being highly efficient.

What is the expected rate of return for a stock that has a beta of 1 if the expected return on the market is 15%?

a. 15%.

b. More than 15%.

c. Cannot be determined without the risk-free rate.
See all solutions

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