Question #8
Reading: Reading 36 Using Multifactor Models
PDF File: Reading 36 Using Multifactor Models.pdf
Page: 4
Status: Correct
Correct Answer: A
Question
One of the assumptions of the arbitrage pricing theory (APT) is that there are no arbitrage opportunities available. An arbitrage opportunity is:
Answer Choices:
A. a factor portfolio with a positive expected risk premium
B. an investment that has an expected positive net cash flow but requires no initial investment
C. a portfolio with factor exposures that sum to one
Explanation
One of the three assumptions of the APT is that there are no arbitrage opportunities
available to investors among these well-diversified portfolios. An arbitrage opportunity is
an investment that has an expected positive net cash flow but requires no initial
investment.
All factor portfolios will have positive risk premiums equal to the factor price for that
factor. An arbitrage opportunity does not necessarily require a return equal to the risk-
free rate, and the factor exposures for an arbitrage portfolio are all equal to zero.