- CFA Exams
- CFA Level I Exam
- Study Session 16. Portfolio Management (1)
- Reading 44. Using Multifactor Models
- Subject 1. Arbitrage pricing theory

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**CFA Practice Question**

The feature of the Arbitrage Pricing Theory (APT) that offers the greatest potential advantage over the CAPM is the ______.

A. identification of anticipated changes in production, inflation, and term structure of interest rates as key factors explaining the risk-return relationship

B. variability of coefficients of sensitivity to the APT factors for a given asset over time

C. use of several factors instead of a single market index to explain the risk-return relationship

**Explanation:**The security market line equation is called the CAPM. The CAPM is a single risk factor model which attempts to predict the expected return on an asset given the expected market return and a stock's beta coefficient.

APT is a competing asset valuation model that assumes that many risk factors besides market risk drive stock returns. A multi-factor model, the APT relies on the assumptions that capital markets are competitive, investors prefer more wealth to less, and zero arbitrage exists. APT does not identify the risk factors to be included in the model. If only market risk is used, APT would equal CAPM.

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