Question 3 (20 marks) You have divided the whole market in 4 portfolios based on 2 dimensions: Value/Growth and Small/Large. The weight of each portfolio in the index is given. The risk-free rate is 1%. Moreover, you have built the following model: Portfolios Weight Sensitivity, BI, to Sensitivity, BII, Sensitivity, BIII, to Factor I (Market to risk) Factor II Factor III (Price/Book) (Average Capitalization) Small Value 10% 0.8 1.05 0.6 Small Growth 15% 1.2 1.15 0.7 Large Value 30% 0.7 1.03 1.04 Large Growth 45% 1.1 0.7 1.01 Risk premium 6% 3% 1% 1. Using the APT, which portfolio has the highest expected return? (10 marks) 2. Using the APT, what is the expected return of the market? (2 marks) 3. One of your competitors uses the CAPM. Based on the betas above, which portfolio will he choose to maximise his expected return? (8 marks)