You are the lead manager of a large mutual fund. You have become aware that several eq- uity analysts who have recently joined your management team are interested in under- standing the differences between the capital asset pricing model (CAPM) and arbitrage pricing theory (APT). In particular, they are interested in how these two asset pricing models can help them perform better security analysis.
a. Explain what the CAPM and APT attempt to model. What are the main differences between these two asset pricing models?
b. Under what circumstances would the APT be preferred over the CAPM as a tool for selecting stocks for the fund portfolio?