Chapter 2: Q4CP. (page 230)

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

Expert verified

The Correct answer is ‘a’ is incorrect while ‘b’ is correct.

Step by step solution

CAPM requires the mean-variance efficient portfolio but Arbitrage Pricing Theory does not require it. Therefore this statement is incorrect.

“The CAPM assumes that one specific factor explains security returns but APT does not”. This statement is correct.

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Statement Number	Statement
1	Investments should offer strong return potential but with very limited risk. I prefer to be conservative and to minimize losses, even if I miss out on substantial growth opportunities.
2	All nongovernmental investments should be in industry-leading and financially strong companies.
3	Income needs should be met entirely through interest income and cash dividends. All equity securities held should pay cash dividends.
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