Arbitrage Pricing Theory The returns on three equities, A, B and C, are given by the following:

R A

=

2.4%  + 0.5 F 1 R B = 4.6%  + 1.2 F 1  − 0.5 F 2 R C

=

4.1% –0.4 F 1  + 0.6 F 2

(a) Are the returns correlated? Explain.

(b) Assume that you have another equity, D. This equity’s returns are generated as:

R D = α +  F 1  +  F 2 If there are no arbitrage possibilities, what is the value of α?