Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

2. Consider the following securities and their sensitivities to two factors the factors have zero means): Stock A: 14,1 = 8 + 5F1,1 +6F2, +

image text in transcribed
2. Consider the following securities and their sensitivities to two factors the factors have zero means): Stock A: 14,1 = 8 + 5F1,1 +6F2, + ea,t Stock B: 13,1 = 6+4F1,+1F2,4 + 8,1 Riskfree: rp=1 a. Construct a portfolio out of stocks A and B which is riskless in terms of factor 2. You may sell short either A or B if necessary. (i) What are w, and WB for this portfolio? How sensitive is this portfolio to factor 1 (that is, how many units of factor 1 risk)? (iii) Given your answers to a) and b), what is the risk premium per unit of factor 1 risk, 21? b. Construct a portfolio out of stocks A and B which is riskless in terms of factor 1. You may sell short either A or B if necessary. (i) What are wa and we for this portfolio? (ii) How sensitive is this portfolio to factor 2 (that is, how many units of factor 2 risk)? (iii) Given your answers to a) and b), what is the risk premium per unit of factor 2 risk, 22? c. Given your answers to a.(iii) and b. (iii), what does the APT predict the returns would be on the above securities? (Hint: I'm not looking for the intercept a). d. What does APT predict the return should be for stock C? Stock C: rc, = 5 + 3F, +4F2, + cc, e. Is stock C underpriced or overpriced? How would you exploit this arbitrage opportunity? Explain your strategy. 2. Consider the following securities and their sensitivities to two factors the factors have zero means): Stock A: 14,1 = 8 + 5F1,1 +6F2, + ea,t Stock B: 13,1 = 6+4F1,+1F2,4 + 8,1 Riskfree: rp=1 a. Construct a portfolio out of stocks A and B which is riskless in terms of factor 2. You may sell short either A or B if necessary. (i) What are w, and WB for this portfolio? How sensitive is this portfolio to factor 1 (that is, how many units of factor 1 risk)? (iii) Given your answers to a) and b), what is the risk premium per unit of factor 1 risk, 21? b. Construct a portfolio out of stocks A and B which is riskless in terms of factor 1. You may sell short either A or B if necessary. (i) What are wa and we for this portfolio? (ii) How sensitive is this portfolio to factor 2 (that is, how many units of factor 2 risk)? (iii) Given your answers to a) and b), what is the risk premium per unit of factor 2 risk, 22? c. Given your answers to a.(iii) and b. (iii), what does the APT predict the returns would be on the above securities? (Hint: I'm not looking for the intercept a). d. What does APT predict the return should be for stock C? Stock C: rc, = 5 + 3F, +4F2, + cc, e. Is stock C underpriced or overpriced? How would you exploit this arbitrage opportunity? Explain your strategy

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image_2

Step: 3

blur-text-image_3

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Income Tax Fundamentals 2013

Authors: Gerald E. Whittenburg, Martha Altus Buller, Steven L Gill

31st Edition

1111972516, 978-1285586618, 1285586611, 978-1285613109, 978-1111972516

More Books

Students also viewed these Finance questions

Question

=+ Where would most corporations like the balance to fall?

Answered: 1 week ago