Information given here about three investments listed in S&P500. Expected returns, variances, and correlations with the market are available in the table below.

Correlations____________

Securitys2ABCS&P500

A0.170.01691.00.40.40.2

B0.130.03611.00.60.5

C0.090.00491.00.9

S&P5000.070.00501.0

The risk-free rate is around 4%.

Note: s2 refers to the variance

Required:

1. Determine the expected return and risk for a portfolio composed of 25% of security A and 75% of security B.

2. What would be the optimal portfolio if the investor combines security A with security C?

3. Calculate the return of security A under the capital asset pricing model (CAPM).

4. Suppose a sizeable, fully diversified portfolio has an inflation factor (Fi) beta of .9, a market size (Fsz) beta of 1.4. IfFichanged by 1.2% andFszdeclined by 2%, what will be the actual rate of return of investment B based on a two-factor arbitrage pricing model?

5. Suppose stock C has an actual return of 12% compared to its expected return of 9% above. The beta ofFiis .9 and the beta ofFGNPis 1.5. If inflation unexpectedly increased by 1.4%, what was the unexpected change in GNP?

6. In a multifactor model, explain what a factor represents and the role that beta plays in relation to factors. How do factors and betas affect the actual return?