The APT expected return relationship looks very similar to the security market line that was derived in the capital asset pricing model. Review the differences between the APT and CAPM. (25 marks)

Assume a two-factor APT model is appropriate for asset returns, and there are an infinite number of assets in the economy. Two factors drive expected return: the percentage change in GDP and interest rates. The crosssectional relationship between expected return and factor betas indicates that GDP is expected to grow by 5 per cent and interest rates will grow by 2 per cent. You have estimated factor betas for equities X and Y as follows:
Equity β1 β2 X 2.3 1.9 Y 0.6 −0.5