Orb Trust has historically leaned toward a passive management style of its portfolios. The

only model that Orb's senior management has promoted in the past is the capital asset

pricing model $($CAPM$).$ A consultant suggests Orb use arbitrage pricing theory $($APT$)$

instead. In comparing CAPM and APT, the consultant made the following arguments:

i$.$ Both the CAPM and APT requires a mean$-$variance efficient market portfolio

ii$.$ Neither the CAPM nor APT assumes normally distributed security returns

iii. The CAPM assumes that one specific factor explains security returns but APT

does not.

a$.$ State whether each of the consultant's arguments is correct or incorrect. Indicate, for

each incorrect argument, why the argument is incorrect.

Now orb's management has asked one of its analysts, Kevin, CFA, to investigate the use of

the arbitrage pricing theory $($APT$)$ model.

Kevin believes that a two$-$factor APT model is adequate, where the factors are the

sensitivity to changes in real GPD and changes in inflation. Kevin has concluded that

the factor risk premium for real GDP is $8\%$ while the factor risk premium for inflation

is $2\%.$

Kevin estimates for Orb's High Growth Fund that the sensitivities to thee two factors

are $1\mathrm{.}25$ and $1\mathrm{.}5,$ respectively.

Kevin also estimates for Orb's Large Cap Fund, and finds that the sensitivities to real

GDP and inflation are $0\mathrm{.}75$ and $1\mathrm{.}25,$ respectively.

Assume that the risk$-$free rate is $4\%.$

b$.$ According to the APT, what should be Kevin's estimate of the expected return of Orb's

High Growth Fund?

c$.$ According to the APT, what should be Kevin's estimate of the expected return of Orb's

Large Cap Fund?

Kevin's manager at Orb, Jay, asks Kevin to compose a portfolio that has a unit

sensitivity to real GDP growth but is not affected by inflation. Kevin is confident in his

APT estimates for the High Growth Fund and the Large Cap Fund. He then computes

the sensitivities for a third fund, Orb's Utility Fund, which has sensitivities to real GDP

and inflation rate equal to $1\mathrm{.}0$ and $2\mathrm{.}0,$ respectively. He then uses his APT results for

these three funds to accomplish the task of creating a portfolio which include Orb's

High Growth Fund, Large Cap Fund and Utility Fund, and is with a unit exposure to

real GDP and no exposure to inflation. He calls the fund the GDP Fund. d$.$ What should be the weight of the Utility Fund in the newly created GDP Fund?

e$.$ Kevin$$s manager, Jay, says that the GDP Fund would be good for clients who are

retirees who live off the steady income of their investments. Kevin says that the fund

would be a good choice if upcoming supply$-$side macroeconomic policies of the

government are successful. Whose comments do you agree with and why? NOTE $-$ Picture cut off the last $2$ questions. I have typed those there. Thanks so much in advance!