Question 1 In the context of a one-factor arbitrage pricing theory model, consider two assets (which represent the entirety of a small, two-asset economy). Asset one has an expected return of 10% and a factor sensitivity of 0.8 ; and asset two has an expected return of 8% and a factor sensitivity of 1.1. As a result of arbitrage action, which of the following is most likely to occur? A The price of asset one falls and the price of asset two rises B The price of asset one rises and the expected return on asset two falls C The expected return on asset two falls and the price of asset two falls D The price of asset two falls and the expected return on asset one falls E The expected return on asset one rises and the price of asset two falls Question 2 Which of the following statements about portfolio theory and asset pricing is most likely to be true? A Diversifiable risk relates to how an asset's returns are affected by macroeconomic factors such as business cycles, government policy and changes in interest rates B Portfolios on the Efficient Frontier have the maximum risk for a given level of return C Risk-averse investors will choose portfolios closer to the risk-free asset on the Capital Market Line by investing all of their money in the market portfolio D The composition of the market portfolio could change over time E Central to the Capital Asset Pricing Model is the existence of a linear relationship between total risk and return, which is defined by the Security Market Line Question 3 Information about two risky assets and the market portfolio in an economy is given below. Assuming that the Capital Asset Pricing Model holds in this economy, the expected return of the market portfolio is 16% and the risk-free rate is 4%, which of the following statements is most likely to be true? A The expected return of Asset 1 is 16.96% B Beta of Asset 2 is 1.5 C The expected return of Asset 2 is higher than that of Asset 1 D Beta of Asset 1 is higher than that of Asset 2 E An asset with a beta of 0.5 would have an expected return of 8% in this economy