Question
Suppose the two factor portfolios, here called portfolios 1 and 2, have expected returns E ( r_1 ) = 12% and E ( r_2 )
Suppose the two factor portfolios, here called portfolios 1 and 2, have expected returns E ( r_1 ) = 12% and E ( r_2 ) = 10%. Suppose further that the risk-free rate is 4%. Now consider an arbitrary well-diversified portfolio (P), with beta on the first factor, _P1=1.5, and on the second factor, _P2=-0.5. (5 points) If the multifactor APT holds, what is expected return of the portfolio? (10 points) If the portfolio actually has a risk premium of 8%, is this portfolio fair valued? If it not fair-valued, how can you construct a zero-investment and zero-beta portfolio to explore an arbitrage opportunity? (5 points) If you want to make a profit of 1 million dollars from this portfolio, what are the dollar amount investments in portfolio P, portfolio 1, portfolio 2 and risk-free assets?
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