Explanation:
APT (Arbitrage Pricing Theory) is more flexible than CAPM because it allows multiple sources of systematic risk instead of assuming that all systematic risk can be captured by a single market factor. This makes APT a more general model for explaining expected returns and better reflects the complexity of real-world asset pricing.
B is incorrect. Although APT can be simplified to a single-factor form, its flexibility comes from allowing multiple factors, not the ability to collapse into one.
C is incorrect: APT indeed doesn't depend on a market portfolio, but that's not the reason for its flexibility — it's because of its multi-factor approach.
D is incorrect: This is tricky but incorrect — APT doesn't “eliminate” the need for systematic risk modelling; in fact, it explicitly relies on multiple systematic (not idiosyncratic) factors to explain returns. It only assumes that idiosyncratic risk is diversified away.
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Q.236 Which of the following best explains why the APT is considered more flexible than the CAPM?
A
It uses multiple systematic factors, not just a single aggregated factor, to represent the total market risk.
B
Just like the CAPM, the APT allows for the use of a single factor through the single factor model which can be extended to include more factors.
C
With the APT, the benchmark portfolio in the security market line does not have to be the true market portfolio.
D
The APT eliminates the need for an equilibrium market portfolio assumption by focusing entirely on idiosyncratic risk.
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