Question
5. Assume that there are two factors that price assets. Interest rate r = 3%. You have the following information about two well-diversified arbitrage-free
5. Assume that there are two factors that price assets. Interest rate r = 3%. You have the following information about two well-diversified arbitrage-free risky assets. Total: 35 marks. Asset 1 2 E(r) B B 15% 1.5 1 12% 1 1.5 Answer the following questions: (a) Calculate the risk premium of two risk factors. (15 marks) (b) There is a third well-diversified portfolio with 8 = 1.2 and 3= 0.8. What is this portfolio's arbitrage free expected return? (5 marks) (c) Suppose the forecasted return of the portfolio in the question (b) is 10%. Show how you could construct an arbitrage portfolio. (15 marks)
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