Question 3 (15 marks)

After graduating from JCU with a Banking & Finance degree, you work as aquantitative analysis in a boutique hedge fund. One of your job responsibilities is todesign the investment strategies. You strongly believe that all risky assets should bepriced by CAPM. Thus, you would like to apply the CAPM theory to constructing aninvestment portfolio.Required:

a) Write down the steps (no calculation) to show how you would carry out the long-short strategy based on CAPM in practice.(6 marks)

b) During the risk-on period, investors expect a better growth prospect andperformance of the market. According to CAPM, which characteristic(s) ofstocks should have a better performance? How does it affect your securitymarket line (SML) when money is cheap during risk-on period?(5 marks)

c) You suspect that there are other risks should be priced in CAPM. What are thepossible risk factors you would consider and include them in your asset pricingmodels?(4 marks)