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

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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

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