Two common factors, F1 and F2, drive stock returns. We have the following factor equations for stocks 1, 2, and 3:

r1 = 0.07 + 1F 1 1F 2 + 1

r1 = 0.11 + 1F 1 + 1F 2 + 2

r1 = 0.16 + 2F 1 + 1F 2 + 3

Assume that these stocks are priced correctly.

What are the weights of the first pure factor portfolio, that is, a portfolio that has loadings of 1 and 0 on the two factors?

What is the riskless rate?

What are the risk premiums of the two factors?

We have another stock with loadings of 1 = 1 and 2 = 2. This stocks expected return is 10%. Is this stock mispriced relative to the other stocks? Explain.