Problem 1 (40') Consider the multifactor APT. There are two economic factors, Fi and F2, and they are independent. The risk-free rate of return is 6%. The following information is available about two well-diversified portfolios: Portfolio A Portfolio B Factor Sensitivity for F1 Bai = +1.0 +2.0 Factor Sensitivity for F2 Annual Expected Return BAZ = +2.0 19% BB2 = +2.0 22% BB1 - Assume portfolios A and B are efficiently priced. Please answer following questions. A) What is the risk premium of the unit portfolio of Fi? What is the risk premium of the unit portfolio of F2? B) We want to construct Fi's unit portfolio using portfolios A, B, and the risk-free asset. What are the weights on A, B, and the risk-free asset? C) We want to construct F2's unit portfolio using portfolios A, B, and the risk-free asset. What are the weights on A, B, and the risk-free asset? D) We observe a well-diversified portfolio C. Its betas on F and Fy are Bc1 = 2.0 and Bc2 = 0, and its annual expected return is 16%. Is portfolio C underpriced, or overpriced? E) If you want to construct a risk-free arbitrage strategy to exploit the mispricing in part (D), you need to short sell a hedging portfolio. How will you construct the hedging portfolio using portfolios A, B, and the risk-free asset? (Write down the weights) Problem 1 (40') Consider the multifactor APT. There are two economic factors, Fi and F2, and they are independent. The risk-free rate of return is 6%. The following information is available about two well-diversified portfolios: Portfolio A Portfolio B Factor Sensitivity for F1 Bai = +1.0 +2.0 Factor Sensitivity for F2 Annual Expected Return BAZ = +2.0 19% BB2 = +2.0 22% BB1 - Assume portfolios A and B are efficiently priced. Please answer following questions. A) What is the risk premium of the unit portfolio of Fi? What is the risk premium of the unit portfolio of F2? B) We want to construct Fi's unit portfolio using portfolios A, B, and the risk-free asset. What are the weights on A, B, and the risk-free asset? C) We want to construct F2's unit portfolio using portfolios A, B, and the risk-free asset. What are the weights on A, B, and the risk-free asset? D) We observe a well-diversified portfolio C. Its betas on F and Fy are Bc1 = 2.0 and Bc2 = 0, and its annual expected return is 16%. Is portfolio C underpriced, or overpriced? E) If you want to construct a risk-free arbitrage strategy to exploit the mispricing in part (D), you need to short sell a hedging portfolio. How will you construct the hedging portfolio using portfolios A, B, and the risk-free asset? (Write down the weights)
