Part II. Numerical questions (70 points in total) find the following coefficients. You also estimate risk premiums for each factor. Calculate the 1. (15 points) You estimate the Fama-French 3-factor model for the two stocks, A and B, a cost of equity capital (i.e., expected rate of return) for each company using the 3-factor APT model. The risk-free rate is 2%. Stock Mkt SMB HML A 2.1 1.5 -2.0 B 1.0 2.0 1.5 blod Risk premiums 2% 4% 5% 3. (25 points) Portfolio i's return is described by the following two-factor model: ri Tr+1.2(rm - Tr)+0.4(re-rr)- 1%, where rm is the return on the market index, re is the return on a real estate index and rr is the risk-free rate. (a) (15 points) Construct a pure arbitrage trade using the market index, a real estate index, a risk-free asset (such as T-bills) and Portfolio i. What are your overall weights in each asset? (b) (5 points) What is the expected return on Portfolio i if the risk-free rate is 2%, the expected return on the market is 4%, and the expected return on the real estate index is 3%? What should the expected return be if there was no arbitrage in the market? (c) (5 points) If you have $100 million invested in your arbitrage portfolio (from part a), what will be your profit at the end of the period if the return on the market is 20%, the return on the real-estate index is 10% and the risk-free rate is 2% during this period? 4. (20 points) A call option on the Swiss franc (SF) with a strike price of 50 cents is trading for 5 cents and a put option on SF with the same trike price is trading for 6 cents. Here, options represent the right to buy or sell one SF at the given strike price. Consider an option strategy of "writing" (i.e., selling) two call options and selling four put options. (Assume that the contract size of one option is one unit of SF.) (a) Graph the combined profit schedule of this investment strategy against the future spot exchange rate (S/SF). (5 points) (b) Solve and indicate the break-even future exchange rates at which the profit for the investment strategy is zero. (15 points)