In this problem you will construct a "global leverage" factor. Assume you believe that history will repeat itself, and "expected" will be similar to historical averages. "Leverage" is computed as D/Assets ratio.

1) Assume you are told that low leverage stocks provide higher historical returns than high leverage stocks. Explain how would you construct zero-capital portfolio with positive expected return based on that information.

2) How would you create zero-capital, zero market beta portfolio with positive expected return based on the same information? (We could call this factor GlobalLev).

3) Assume GlobalLev is an important factor for explaining returns of mutual funds. Does that mean that GlobalLev is systematically important for financial markets, and how one would test that?

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To construct a zerocapital portfolio with a positive expected return based on the information that low leverage stocks provide higher historical returns than high leverage stocks you would take a long ... View the full answer