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Tracking Portfolio- Example Consider three securities whose expected returns and factor sensitivities are given by: rA = 0.45 + 1.5F1 4F2 + A rB =

Tracking Portfolio- Example

Consider three securities whose expected returns and factor sensitivities are given by:

rA = 0.45 + 1.5F1 4F2 + A

rB = 0.05 + 3F1 + 2F2 + B

rC = 0.08 + 1.2F1 + 0F2 + C

Suppose we wish to construct a tracking portfolio with 1 = 1.8 and 2 = 1.

Determine the proportion to be invested in each security.

Simultaneous Equations

xA + xB + xC = 1

1.5xA + 3xB + 1.2xC = 1.8

4xA + 2xB + 0 = 1

solution: xA = 0.08; xB = 0.35; xC = 0.73

Could you please explain what is happening in this example. I don't understand what the point of this is and what they are solving for and how they are getting the first simultaneous equation.

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