Q3: There are two priced risk factors, GDP risk factor and interest rate (IR) risk factor. Portfolio A is well-diversified across the two factors: Factor Loadings Factor Risk Premiums A,GDP = 1.25 E(rGDP)-rf = 0.06 A,IR = 0.5 E(rIR)-rf = 0.08 rf = 0.04 You expect the portfolio will actually earn 16%. To take advantage of the mispricing, you would:

1.Buy asset A, short sell GDP factor, sell IR factor, buy Rf

2.Buy asset A, buy GDP factor, short sell IR factor, buy Rf

3.Short sell asset A, buy GDP factor, buy IR factor, borrow at Rf

4.None of the above

Please support your answer with an example of the constructed Arbitrage portfolio with sample numbers and why would you choose each different part of the answer.