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    Arbitrage portfolio - factor model

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    1) In what significant does the APT differ from CAPM ?

    2) Why would an investor wish to form an arbitrage portfolio ?

    3) What three conditions define an arbitrage portfolio ?

    4. Assuming a one-factor model, consider a portfolio composed of three securities with the following factor sensitivities:

    Security --- Factor Sensitivity

    1 -- 0.90
    2 -- 3.00
    3 -- 1.80

    If the proportion of security 1 on the portfolio is increased by .2 how must the proportions of the other two securities change if the portfolio is to maintain the same factor sensitivity ?

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    Solution Preview

    See attached file.

    1) In what significant does the APT differ from CAPM ?

    a APT makes lesser number of assumptions than CAPM. In some ways is less complicated than CAPM.
    b The market portfolio that is central to CAPM does not feature in APM.
    c APT does not tell what the underlying factors are unlike CAPM which relates the return on the asset/portfolio of assets
    on a single factor (the return on the market portfolio).

    2) Why would an investor wish to form an arbitrage portfolio ?

    An investor wishes to form an arbitrage portfolio to increase ...

    Solution Summary

    The solution explains the differences between APT and CAPM. It also discusses arbitrage portfolio and factor sensitivity

    $2.19

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