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5. Investors attribute all securities' systematic risks to one factor, F. Suppose portfolios A, B, and C are well-diversified. We know B E(r) A B
5. Investors attribute all securities' systematic risks to one factor, F. Suppose portfolios A, B, and C are well-diversified. We know B E(r) A B 1 1.5 35% 50% C 0.5 20% (a) Is there an arbitrage opportunity? If so, construct a trading strategy to earn profits with no risk. If not, why? [4 points] (b) There is another portfolio D. Portfolio D's factor loading is 0.8, and its expected rate of return is 28%. If D is also well-diversified. Please construct a trading strategy to earn profits without any risk. (Hint: You will hold $1000 long position for one portfolio and $1000 short position for another portfolio. Show that there is no risk, and you can get positive return.] [6 points) (c) After some market adjustments, portfolio D's expected rate of return increases to 29%. Portfolios A, B, and C are all fairly priced according to Arbitrage Pricing Theory. However, more analysis shows that portfolio D is actually NOT well- diversified. Will any investor want to hold portfolio D? Why? (2 points] 5. Investors attribute all securities' systematic risks to one factor, F. Suppose portfolios A, B, and C are well-diversified. We know B E(r) A B 1 1.5 35% 50% C 0.5 20% (a) Is there an arbitrage opportunity? If so, construct a trading strategy to earn profits with no risk. If not, why? [4 points] (b) There is another portfolio D. Portfolio D's factor loading is 0.8, and its expected rate of return is 28%. If D is also well-diversified. Please construct a trading strategy to earn profits without any risk. (Hint: You will hold $1000 long position for one portfolio and $1000 short position for another portfolio. Show that there is no risk, and you can get positive return.] [6 points) (c) After some market adjustments, portfolio D's expected rate of return increases to 29%. Portfolios A, B, and C are all fairly priced according to Arbitrage Pricing Theory. However, more analysis shows that portfolio D is actually NOT well- diversified. Will any investor want to hold portfolio D? Why? (2 points]
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