Question 4 Beta on F1 1 Suppose APT holds and there are two independent risk factors, Fi and F2. The risk-free rate is 2%. The following table provides the information on two well-diversified portfolios that are in equilibrium: Portfolio Beta on F2 Expected Return 0.5 10% Y 0.5 1.5 11% a) Compute the risk premium for the two risk factors and write down the expected return-beta relationship. b) A well-diversified portfolio A, with a beta of 0.9 on F, and 1.2 on F2, currently offers an expected return of 13%. Is portfolio A a good investment and why? c) Following up on part b, is there an arbitrage opportunity? If so, what would be the arbitrage strategy and what is the arbitrage profit? (22 marks)