Random returns for two wellndashdiversified portfolios at, Ask an Expert

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Random returns for two well–diversified portfolios at time t are given by:

rAt= 0:27 + 2F1t+ 0:8F2t

rBt= 0:161 +F1t+ 1:1F2t;

Where F1and F2 are unexpected parts of factor 1 and 2 returns, respectively. (One can think that factor one is GDP and factor two is inflation). The risk free rate is 1:0%.

a. Construct factor portfolio for factor 1 by combining portfolios A, B, and T-bills. What are the weights of these portfolios in factor portfolio 1? What is the expected return of factor portfolio 1?

b. Solve question for factor portfolio 2

c. Assume that the market does not allow arbitrage strategies and so the two–factor APT holds. Find the expected returns on portfolio C which betas with respect to factors 1 and 2 are 0.5 and 1.2, respectively

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Financial Management, Finance

Category:- Financial Management
Reference No.:- M91600915

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