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Arbitrage Pricing Theory (APT) |
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Definition of Arbitrage Pricing Theory (APT)Arbitrage Pricing Theory (APT)An alternative model to the capital asset pricing model developed by
Related Terms:Administrative pricing rulesIRS rules used to allocate income on export sales to a foreign sales corporation. Agency theoryThe analysis of principal-agent relationships, wherein one person, an agent, acts on behalf of ArbitrageThe simultaneous buying and selling of a security at two different prices in two different markets, ArbitrageThe purchase of securities on one market for immediate resale on ArbitrageTransactions designed to make a sure profit from inconsistent prices. Arbitrage-free option-pricing modelsYield curve option-pricing models. ArbitrageursPeople who search for and exploit arbitrage opportunities. Asset pricing modelA model for determining the required rate of return on an asset. Asset pricing modelA model, such as the Capital Asset pricing Model (CAPM), that determines the required Binomial option pricing modelAn option pricing model in which the underlying asset can take on only two Black-Scholes option-pricing modelA model for pricing call options based on arbitrage arguments that uses Bubble theorySecurity prices sometimes move wildly above their true values. Call swaptionA swaption in which the buyer has the right to enter into a swap as a fixed-rate payer. The Capital asset pricing model (CAPM)An economic theory that describes the relationship between risk and Capital Asset Pricing Model (CAPM)A model for estimating equilibrium rates of return and values of capital asset pricing model (CAPM)theory of the relationship between risk and return which states that the expected risk Captive AgentA licensed insurance agent who sells insurance for only one company. Cost-plus pricingA method of pricing in which a mark-up is added to the total product/service cost. Covered interest arbitrageA portfolio manager invests dollars in an instrument denominated in a foreign Currency arbitrageTaking advantage of divergences in exchange rates in different money markets by dual pricing arrangementa transfer pricing system that allows expectations theory of exchange ratestheory that expected spot exchange rate equals the forward rate. Garmen-Kohlhagen option pricing modelA widely used model for pricing foreign currency options. Index arbitrageAn investment/trading strategy that exploits divergences between actual and theoretical Liquidity theory of the term structureA biased expectations theory that asserts that the implied forward Local expectations theoryA form of the pure expectations theory which suggests that the returns on bonds Market segmentation theory or preferred habitat theoryA biased expectations theory that asserts that the Modern portfolio theoryPrinciples underlying the analysis and evaluation of rational portfolio choices Normal backwardation theoryHolds that the futures price will be bid down to a level below the expected One-factor APTA special case of the arbitrage pricing theory that is derived from the one-factor model by pecking order theoryFirms prefer to issue debt rather than equity if internal finance is insufficient. Preferred habitat theoryA biased expectations theory that believes the term structure reflects the Pricing efficiencyAlso called external efficiency, a market characteristic where prices at all times fully Pure expectations theoryA theory that asserts that the forward rates exclusively represent the expected Put swaptionA financial tool in which the buyer has the right, or option, to enter into a swap as a floatingrate Quantity Theory of Moneytheory that velocity is constant, and so a change in money supply will change nominal income by the same percentage. Formalized by the equation Mv = PQ. random walk theorySecurity prices change randomly, with no predictable trends or patterns. Real Business Cycle TheoryBelief that business cycles arise from real shocks to the economy, such as technology advances and natural resource discoveries, and have little to do with monetary policy. Regulatory pricing riskRisk that arises when regulators restrict the premium rates that insurance companies Risk arbitrageSpeculation on perceived mispriced securities, usually in connection with merger and Risk controlled arbitrageA self-funding, self-hedged series of transactions that generally utilize mortgage Riskless arbitrageThe simultaneous purchase and sale of the same asset to yield a profit. Static theory of capital structuretheory that the firm's capital structure is determined by a trade-off of the Structured arbitrage transactionA self-funding, self-hedged series of transactions that usually utilize SwaptionOptions on interest rate swaps. The buyer of a swaption has the right to enter into an interest rate SwaptionA swap option; an option on an interest-rate swap. The option gives Target rate of return pricingA method of pricing that estimates the desired return on investment to be achieved from the theory of constraints (TOC)a method of analyzing the bottlenecks trade-off theoryDebt levels are chosen to balance interest tax shields against the costs of financial distress. Triangular arbitrageStriking offsetting deals among three markets simultaneously to obtain an arbitrage profit. Two-state option pricing modelAn option pricing model in which the underlying asset can take on only two UnderpricingIssue of securities below their market value. underpricingIssuing securities at an offering price set below the true value of the security. Yield curve option-pricing modelsModels that can incorporate different volatility assumptions along the
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