Two common factors f1 and f2 drive stock returns we have, Ask an Expert

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

r˜1 = 0.07 + 1F˜ 1 − 1F˜ 2 + ˜ε1

r˜1 = 0.11 + 1F˜ 1 + 1F˜ 2 + ˜ε2

r˜1 = 0.16 + 2F˜ 1 + 1F˜ 2 + ˜ε3

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 β1 = 1 and β2 = 2. This stock’s expected return is 10%. Is this stock mispriced relative to the other stocks? Explain.

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Financial Management, Finance

Category:- Financial Management
Reference No.:- M92716661

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