Assume that you are in the two-factor exact APT world. There are two portfolios (portfolio 1 and portfolio 2) which have loadings on the two factors as follows:

Loadings factor 1 factor 2

portfolio 1 1.67 0.59

portfolio 2 1.38 -1.04

The expected return on portfolio 1 is 7.46% and the expected return on portfolio 2 is 13.73%. The risk-free rate is 2.32%.

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Construct the factor portfolios(factor-mimicking portfolios) for factor1 and factor 2, respectively.

Factor 1, weight on portfolio 1:

Factor 1, weight on portfolio 2:

Factor 2, weight on portfolio 1:

Factor 2, weight on portfolio 2:

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What is the risk premium of each factor (in %)?

RP1: %

RP2: %

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There is a new portfolio just formed (portfolio 3). It has loadings of 3 and 1.5 on factor 1 and 2, respectively. The expected return on this portfolio is 10%. Is this consistent with APT? If it is consistent with the APT fill the boxes below with zeros. If not, construct an arbitrage strategy that generates $100 today for sure and costs nothing in the future.

$ invested in portfolio 1:

$ invested in portfolio 2:

$ invested in portfolio 3:

$ invested in the riskless asset: