Assume the assumptions of Arbitrage Pricing Theory hold and a three-factor model describes the realized returns. All other risk is diversifiable. Assume that factors are normalized so that E[] = E[fj] = E[F3] The risk-free rate is rf = 2% = 0.02 and you are given the multi-factor representation of three risky assets: A = 0.05 + 1 + ZA s = 0.02 Fi + 2 + B fc = 0.085 0.5. + Fz + Fz +c where risks A, ZB, &c are diversifiable/idiosyncratic. a) Assume the 3-factor Arbitrage Pricing Theory applies. What are the risk-premia for holding factors 1,2,3? b) Assume the 3-factor Arbitrage Pricing Theory applies. What is the expected return of an asset that has loading 0.75 on factor 1, 0.2 on factor 2, and -0.4 on factor 3? c) Suppose there is an asset with loadings of 1 on each of the factors. The asset has an expected return of 10%. If there arbitrage? If so, construct the arbitrage strategy. Assume the assumptions of Arbitrage Pricing Theory hold and a three-factor model describes the realized returns. All other risk is diversifiable. Assume that factors are normalized so that E[] = E[fj] = E[F3] The risk-free rate is rf = 2% = 0.02 and you are given the multi-factor representation of three risky assets: A = 0.05 + 1 + ZA s = 0.02 Fi + 2 + B fc = 0.085 0.5. + Fz + Fz +c where risks A, ZB, &c are diversifiable/idiosyncratic. a) Assume the 3-factor Arbitrage Pricing Theory applies. What are the risk-premia for holding factors 1,2,3? b) Assume the 3-factor Arbitrage Pricing Theory applies. What is the expected return of an asset that has loading 0.75 on factor 1, 0.2 on factor 2, and -0.4 on factor 3? c) Suppose there is an asset with loadings of 1 on each of the factors. The asset has an expected return of 10%. If there arbitrage? If so, construct the arbitrage strategy