Final answer:
The CAPM assumes a linear relationship between expected return and beta for well-diversified portfolios, while APT allows for multiple risk factors and does not require a portfolio to be well-diversified. Both theories differ significantly in terms of their assumptions and applicability.
Step-by-step explanation:
The Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing Theory (APT) are two important concepts in finance for understanding the expected returns of investments. Addressing the statements provided:
- A. The CAPM does not apply to all securities strictly. It is mainly focused on pricing securities in well-diversified portfolios and assumes a single factor, beta, reflecting market risk to estimate expected returns.
- B. The expected return-beta relationship is foundational to CAPM, which posits a linear relationship between expected return and beta. APT, on the other hand, allows for multiple factors that could affect expected returns, not just market risk, which means the return-beta relationship is not the same for both theories.
- C. APT holds that in the absence of arbitrage, expected returns will align with risk (beta) and potentially other factors. However, it does not 'guarantee' this relationship for all assets as market conditions and factors other than beta can influence expected returns.
- D. The APT does not apply only to well-diversified portfolios. It assumes that investors will take advantage of arbitrage opportunities, and as such, any mispricings will affect only undiversified portfolios, as diversified portfolios will already have this risk arbitrated away.
In conclusion, APT is considered more flexible than CAPM as it can incorporate several different risk factors, not just market risk, and does not require the portfolio to be well-diversified. CAPM, conversely, specifically relates expected return to market risk in well-diversified portfolios.