5. Assuming a one-factor model of the form:

r, = 4% + b;l'+ P.i consider three well-diversified portfolios (zero nonfactor risk) . The expected value of the factor is 8%.

Is one of the portfolio's expected return not in line with the factor model relationship?
Which one? Can you construct a combination of the other two portfolios that has the same factor sensitivity as the "out-of-line" portfolio? What is the expected return of that combination? What action would you expect investors to take with respect to th ese three portfolios?

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Portfolio Factor Sensitivity Expected Return A 0.80 10.4% B 1.00 10.0 C 1.20 13.6