FRM 6. The Arbitrage Pricing Theory and Multifactor Models of Risk and Return

Learning Objectives

1) Explain the Arbitrage Pricing Theory (APT), describe its assumptions, and compare the APT to the CAPM.

2) Describe the inputs (including factor betas) to a multifactor model and explain the challenges of using multifactor models in hedging.

3) Calculate the expected return of an asset using a single-factor and a multifactor model.

4) Explain how to construct a portfolio to hedge exposure to multiple factors.

5) Describe and apply the Fama-French three-factor model in estimating asset returns.