Factor	Factor Risk Premium
Industrial Production (I)	6%
Interest Rates (R)	2%
Consumer Confidence (C)	4%

Suppose that the market can be described by the following three sources of systematic risk with associated risk premiums.

The return on a particular stock i is generated according to the following factor model:

ri = 15% + 1.0 (FI E [FI ]) + 0.5 (FR E [FR]) + 0.75 (FC E [FC]) + ei (1)

in which FI , FR, FC indicates the actual value of industrial production, interest rate, and consumer confidence, respectively. The T-bill rate is 6%.

1) Suppose we have factor portfolios for each of the three factors used in this problem. For simplicity, lets call them portfolio I, portfolio R, and portfolio C to easily distinguish which portfolio tracks which of our three factors. Using these three factor portfolios and the risk-free asset (T-bill), create a portfolio that is identical to stock i. Specifically, what must be the weights on each of the three factor portfolios and the risk-free asset? What is the expected return of this portfolio? [Hint: For the expected return, notice that I gave you the factor risk premium for each of the three factors. To calculate the expected return of a factor portfolio, you want to add the risk-free rate of return to the risk-premium of the factor it is tracking.]

Using the portfolio you constructed in Part (1), tell me how you can form a zero investment portfolio that takes advantage of the mispricing of stock i.