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Suppose that stock returns are generated by a two-factor model. The expected returns and factor sensitivities of two well-diversified mutual funds, Brix and Clix, are
Suppose that stock returns are generated by a two-factor model. The expected returns and factor sensitivities of two well-diversified mutual funds, Brix and Clix, are given in the table below. The risk-free rate is 2%.
Assume that the APT (Arbitrage Pricing Theory) holds. Compute the risk premiums 1 and 2 of the mimicking portfolios associated with factors 1 and 2.
\begin{tabular}{|l|c|c|c|} \hline Mutual fund & Factor beta b1 & Factor beta b2 & Expected return \\ \hline Brix & 0.3 & 0.4 & 8% \\ \hline Clix & 1.5 & 0.8 & 23% \\ \hline \end{tabular}Step by Step Solution
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