You are an investment officer at Pegasus Securities and are preparing for the next meeting of the investment committee. Several committee members are interested in reviewing two asset pricing models – the capital pricing model (CAPM) and the arbitrage pricing theory (APT)- and their use in portfolio management and stock selection.
a. Describe both the CAPM and the APT, and identify the factors(s) that determines returns in each.
b. “The APT model is more general than the CAPM”. Explain how this observation has meaning in the stock selection process.