11/22/2014
ArbitragePricingTheory(APT)Definition&Example|InvestingAnswers
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ArbitragePricingTheory(APT)
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Whatitis:
Arbitragepricingtheory(APT)[Link]
theoryassumesanasset'sreturnisdependentonvariousmacroeconomic,marketandsecurity
specificfactors.
Howitworks/Example:
APTisanalternativetothecapitalassetpricingmodel(CAPM).StephenRossdevelopedthetheoryin
1976.
TheAPTformulais:
RelatedTerms
E(rj)=rf+bj1RP1+bj2RP2+bj3RP3+bj4RP4+...+bjnRPn
Benchmark
where:
E(rj)=theasset'sexpectedrateofreturn
rf=theriskfreerate
bj=thesensitivityoftheasset'sreturntotheparticularfactor
RP=theriskpremiumassociatedwiththeparticularfactor
ThegeneralideabehindAPTisthattwothingscanexplaintheexpectedreturnonafinancialasset:1)
macroeconomic/securityspecificinfluencesand2)theasset'[Link]
relationshiptakestheformofthelinearregressionformulaabove.
ViewAll
NetProfitMargin
PriceMultiple
BookValue
DeferredRevenue
DividendYield
VariableCosts
Thereareaninfinitenumberofsecurityspecificinfluencesforanygivensecurityincludinginflation,
productionmeasures,investorconfidence,exchangerates,marketindicesorchangesininterest
[Link].
Oncetheanalystderivestheasset'sexpectedrateofreturnfromtheAPTmodel,heorshecan
determinewhatthe"correct"priceoftheassetshouldbebypluggingtherateintoadiscountedcash
flowmodel.
[Link],aportfoliocanhave
exposuresandsensitivitiestocertainkindsofriskfactorsaswell.
WhyitMatters:
TheAPTwasarevolutionarymodelbecauseitallowstheusertoadaptthemodeltothesecuritybeing
[Link],ithelpstheuserdecidewhetherasecurityisundervalued
[Link]
portfoliosbecauseitallowsmanagerstotestwhethertheirportfoliosareexposedtocertainfactors.
APTmaybemorecustomizablethanCAPM,butitisalsomoredifficulttoapplybecausedetermining
[Link]
impossibletodetecteveryinfluentialfactormuchlessdeterminehowsensitivethesecurityistoa
[Link]"closeenough"isoftengoodenoughinfactstudiesfindthatfourorfive
factorswillusuallyexplainmostofasecurity'sreturn:surprisesininflation,GNP,investorconfidence
andshiftsintheyieldcurve.
TermoftheDay
BestExecution
Bestexecutionreferstotheimperativethata
broker,marketmaker,orotheragentactingon
behalfofaninvestorisobligatedtoexecutethe
investor'sorderinawaythatismost
advantageoustotheinvestorratherthanthe
agent.
Continuereading...
[Link]
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11/22/2014
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