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In a market in which the Arbitrage Pricing Theory (APT) model holds, the expected return is given by: (i) Define all the terms in the equation. [2] Assume the risk-free rate ry = 0.04. Consider two well diversified portfolios P, with the following features in a two factor model: PI P2 ER 15.50% 11.95% (a) (b 1.5 0.7 (ii] Determine the values (a) and (b) for ), = 0.05 and A2 =0.06. 137 [Total 5] An investor has $1 00 and is considering investing in two different stocks. The prices of both stocks are assumed to follow the lognormal model with the parameters below. Stock Current price Drift , Volatility IT A 59% 20% R 8% 30% (i) Calculate the expected value at time 3 of f100 invested in: (a) stock A (b) stock B. [2] (ii) Calculate the standard deviation at time 3 of (100 invested in: (a) stock A (b) stock B. [4] The investor decides to invest f50 in cach stock. "iii) Calculate the expected value of the investor's purifolio at time 3. [1] The correlation of the two stocks is 0.3. (iv) Calculate the standard deviation of the value of the investor's portfolio at time 3. [3] (v) Comment on the expected return and standard deviation of the portfolio compared to investing the whole f100 in one stock. [4] [Total 14]