Factor Models: You live in a world where asset prices are determined by three factors: The price
Question:
Factor Models: You live in a world where asset prices are determined by three factors: The price of oil, the price of lithium, and a CAPM-style market factor. Below are the returns on several useful assets: \begin{tabular}{|l|l|} \hline Asset & Return \\ \hline Riskless government debt &1.2%\\ \hline \( \begin{array}{l}\text { Well-diversified portfolio of firms exposed to } \\ \text { lithium prices }\end{array} \) &9.1%\\ \hline \( \begin{array}{l}\text { Well-diversified portfolio of firms unaffected by } \\ \text { lithium prices }\end{array} \) &8.8%\\ \hline \( \begin{array}{l}\text { Well-diversified portfolio of firms exposed to oil } \\ \text { prices }\end{array} \) &13.8%\\ \hline \( \begin{array}{l}\text { Well-diversified portfolio of firms unaffected by } \\ \text { oil prices }\end{array} \) &14.9%\\ \hline Broad based index fund &12.4%\\ \hline \end{tabular} a.10points: Using the asset returns above, what are the factor values for each of the three factors? b. 20 points: What would be the expected return on an asset with a market beta of 0.9 , a lithium beta of 1.4 , and an oil beta of -.3 ? c. 10 points: Under the APT, what mechanism is responsible for enforcing the security market line?