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Problem Three (15 points): You are provided the following information for a stock market in which two factors explain returns: Assets j2 0.9 1.1 18%

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Problem Three (15 points): You are provided the following information for a stock market in which two factors explain returns: Assets j2 0.9 1.1 18% Risk-free 0 5% Notation: bik for j = A, and k = 1,2 denote the responses of the rates of return on assets j to factor k ("factor loadings") a) (10 points) If the APT holds, and you are given factor loadings: bB1- 1.5, bB2 0.5, find expressions for the factors' expected excess returns as functions of HB. Explain why these relationships must hold. (5 points) Now assume that that Hy-0.2. Assume that a third asset C has factor loadings bc1 - 0.6, bc2-1.1. Find the estimated value uc b) Problem Three (15 points): You are provided the following information for a stock market in which two factors explain returns: Assets j2 0.9 1.1 18% Risk-free 0 5% Notation: bik for j = A, and k = 1,2 denote the responses of the rates of return on assets j to factor k ("factor loadings") a) (10 points) If the APT holds, and you are given factor loadings: bB1- 1.5, bB2 0.5, find expressions for the factors' expected excess returns as functions of HB. Explain why these relationships must hold. (5 points) Now assume that that Hy-0.2. Assume that a third asset C has factor loadings bc1 - 0.6, bc2-1.1. Find the estimated value uc b)

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