Question
Assume a two-factor APT world where the systematic risks are INFLATION risk and CRUDE risk. The risk-free rate r f is 3%. Assume there exists
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Assume a two-factor APT world where the systematic risks are INFLATION risk and CRUDE risk. The risk-free rate rf is 3%. Assume there exists INFLATION and CRUDE factor portfolios that are tradeable. ( All information given in this question,beta for factor loading provided below)
Portfolio ABC Factor Loading Risk Factor Portfolio Risk Premium INFLATION 1.2 INFLATION 3.2% CRUDE 0.4 CRUDE 6.5%
a)Use the information in the table above to compute the NO-ARBITRAGE expected return for Portfolio ABC.
b)A trader estimates the expected return of Portfolio ABC to be 8.5%. Assume the factor loadings reported in the table are correct. According to the trader, what is the alpha of Portfolio ABC?
c) Refer to part a and b . Assume the trader in part b is correct. Construct a trading strategy that generates an arbitrage profit.
Buy ABC, short INFLATION risk factor portfolio, borrow at the risk-free | ||
Buy ABC, short INFLATION risk factor portfolio, short CRUDE risk factor portfolio, and buy the risk-free asset | ||
Short ABC, short INSFLATION risk factor portfolio, short CRUDE risk factor portfolio, and borrow at the risk-free rate | ||
Short ABC, buy INFLATION risk factor portfolio, buy CRUDE risk factor portfolio, and borrow the risk-free asset | ||
None of the above strategies generate an arbitrage profit |
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