Type of questions expected from "Expected returns and the Arbitrage Pricing Theory" by Grinold

[verma.rahul]

Hi David

Can you please put some light on the type of questions expected from "Expected returns and the Arbitrage Pricing Theory" by Grinold in your view ?
I do not have any clue about this reading after reading it. Everything kinda look theoretical.

Rahul

 

[David Harper CFA FRM]

Hi Rahul,

It's a good question b/c (i) the chapter is newly assigned (versus Grinold 17, which repeats) and (ii) I did not see a single query about APT/this chapter on the FRM sample exam (?!). The best we can do is lean on the AIMs. In particular, IMO, I can imagine questions re: the first four:

* Describe limitations and deficiencies in the CAPM.
* Define and describe the components of the Arbitrage Pricing Theory (APT) model.
* Calculate a security’s expected excess returns using the APT model and interpret the results.
* Discuss the relationship between APT and the CAPM

For paid members, mastery here can be achieve by understanding my learning XLS
located @ http://www.bionicturtle.com/premium/spreadsheet/1.a.5._grinold_apt_7.1_7.2/
(which is also reviewed in the video tutorial; my XLS is merely a blended re-creation of Tables 7.1 and 7.2).

So, my first "tip" here is study tables 7.1 & 7.2; to understand these, I think, requires mastery of the four AIMs above.

In a nutsell, for our practical purpose, APT is merely a generalization of CAPM. So, you've likely seen CAPM questions; e.g., solve for expected excess return given beta and excess market return (equity premium). The analogous APT question would be something like:

* Given the following factor returns (e.g., ROE) and the following factor exposures, what is the stock's expected excess return?

(that's my prediction for a question....see how that is question about the 3rd AIM, the only calc AIM here?)

okay, my second "tip," because personally i find Grinold challenging throughout, to the extent you want to drill deep on this marginal chapter, is to get hold of Amenc Chapter 6 on APT. (the Chapter 4 CAPM is assigned). Amenc Chapter 6 was previously assigned and gives a more accessible intro to APT (and since prior APT questions drew from this source, you are likely to be hitting testable material anyway)

Hope that helps, David

 

[verma.rahul]

I would suggest all to go through the CFA level II notes on APT. The text is superb.