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Assume that the following two-index model describes returns: Ti = rf+biili + bi212. Assume that the following three portfolios are observed: Portfolio Expected return (%)

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Assume that the following two-index model describes returns: Ti = rf+biili + bi212. Assume that the following three portfolios are observed: Portfolio Expected return (%) bil bi2 A 10 0 B 1 0 2 -2 -1 1 (a) According to APT, what is the expected return, factor-loading relationship for this market (i.e. find rf, 11 and 12). (b) Now consider portfolio D with the following characteristics: id = 15%, bpi = 2, bp2 = 1. Is an arbitrage opportunity possible? If yes, then describe the arbitrage opportunity. Assume that the following two-index model describes returns: Ti = rf+biili + bi212. Assume that the following three portfolios are observed: Portfolio Expected return (%) bil bi2 A 10 0 B 1 0 2 -2 -1 1 (a) According to APT, what is the expected return, factor-loading relationship for this market (i.e. find rf, 11 and 12). (b) Now consider portfolio D with the following characteristics: id = 15%, bpi = 2, bp2 = 1. Is an arbitrage opportunity possible? If yes, then describe the arbitrage opportunity

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