After graduating from JCU with a MBA degree in Finance, you work as an investment strategist in a boutique hedge fund. One of your job responsibilities is to design the trading strategies. You strongly believe that all risky assets should be priced or valued by its risk factors. Thus, you would like to apply Fama and French 3-factor (FF3) model to constructing an investment portfolio.

Required:

a. Write down the necessary steps (no calculation) to show how you would carry out the long-short strategy based on FF3 model in practice. (10 marks)

b. Stock markets generally plunged around the world in February 2020. Airlines, hotels and tourism stocks were affected badly, and their stock prices dropped drastically and prolong resulting in a lower portfolios net assets value. Illustrate and explain why these stocks perform so poorly as compared to other stocks during COVID-19 pandemic using the security market line (SML). (10 marks)

c. You suspect that there are other risks in addition to those in FF3 model, i.e., market risk, size and growth factors, should be priced in the risky assets. What are the possible risk factors you would consider and include them in your multifactor asset pricing model? Why? (10 marks)