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8) Consider a two-factor index model, where Fi is the unexpected com- ponent of GDP growth and F2 is the unexpected component of the inflation
8) Consider a two-factor index model, where Fi is the unexpected com- ponent of GDP growth and F2 is the unexpected component of the inflation rate (thus Fi and F2 are orthogonal): Rit = E(Ri) + bliF1t + b2i Fat + Eit. a) Compute the standard deviation of Rit. Distinguish between the sys- tematic and the idiosyncratic components. b) You have identified three well diversified portfolios A, B and C. Their characteristics are: E(Rp) bip A 0.39 1.8 B 0.3256 1.5 0.216 1.1 b2p 2.2 1.642 0.9 Are there arbitrage opportunities? Detail your answer. c) Assume now that all the securities are priced according the following return-beta relationship: E(RP) = lo + lib1p + 12b2p. The risk-free rate is 0.04, the excess return on the portfolio mimicking the first factor is 0.07, while the excess return on the portfolio mimicking the second factor is 0.11. Are portfolios A, B and C correctly priced? Are they undervalued or overvalued? 8) Consider a two-factor index model, where Fi is the unexpected com- ponent of GDP growth and F2 is the unexpected component of the inflation rate (thus Fi and F2 are orthogonal): Rit = E(Ri) + bliF1t + b2i Fat + Eit. a) Compute the standard deviation of Rit. Distinguish between the sys- tematic and the idiosyncratic components. b) You have identified three well diversified portfolios A, B and C. Their characteristics are: E(Rp) bip A 0.39 1.8 B 0.3256 1.5 0.216 1.1 b2p 2.2 1.642 0.9 Are there arbitrage opportunities? Detail your answer. c) Assume now that all the securities are priced according the following return-beta relationship: E(RP) = lo + lib1p + 12b2p. The risk-free rate is 0.04, the excess return on the portfolio mimicking the first factor is 0.07, while the excess return on the portfolio mimicking the second factor is 0.11. Are portfolios A, B and C correctly priced? Are they undervalued or overvalued
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