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Suppose that a market can be described by the following three sources of systematic risk with associated risk premiums: Inflation factor has a 7% risk
Suppose that a market can be described by the following three sources of systematic risk with associated risk premiums: Inflation factor has a 7% risk premium of its factor portfolio; Interest rate factor has a 2% risk premium of it factor portfolio and War factor has a 10% risk premium of its factor portfolio. The return on a particular well-diversified portfolio Pis generated according to the following equation 7 -40% - 1.07 +0.3R +1.5W where I, R, and W are unanticipated components in Inflation, Interest rate, and War, respectively. (6 points) 1. Find the expected rate of return of this portfolio using the APT. The T-bill rate is 7%, is the stock overpriced or underpriced? 2. Is there any arbitrage opportunity? If so, construct one arbitrage strategy
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