Microsoft PowerPoint - PoF.ppt

Expected return and risk relationship 93

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We’ll all be trying to take advantage

of this arbitrage opportunity, selling

short stocks like D, E, and F while

buying stocks such as A, B, and C

• 
  

selling short stocks like D, E, and F

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prices

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Ä

expected rates of return

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• 
  

buying stocks such as A, B, and C

Ä

prices

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prices

’

Ä

expected rates of return

”

• 
  

The effect of all this will be to “unbend” the line until the general relationship is approximately linear

Single-period random cash flows: Factor models - APT

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