The following question illustrates the APT. Imagine that there are only two pervasive macroeconomic factors. Investments X, Y, and Z have the following sensitivities to these two factors:

Investment	b1	b2
X	1.75	.25
Y	−1.00	2.00
Z	2.00	1.00

We assume that the expected risk premium is 4% on factor 1 and 8% on factor 2. Treasury bills obviously offer zero risk premium.

a. According to the APT, what is the risk premium on each of the three stocks? (Do not round intermediate calculations. Enter your answers as a percent rounded to the nearest whole number.)

Stocks	Risk Premiums
X	%
Y	%
Z	%

b-1. Suppose you buy $200 of X and $50 of Y and sell $150 of Z. What is the sensitivity of your portfolio to each of the two factors? (Leave no cells blank, enter "0" wherever required.)

	Sensitivity
Factor 1
Factor 2

b-2. What is the expected risk premium? (Do not round intermediate calculations. Enter your answer as a percent rounded to the nearest whole number.)

Expected risk premium             %

c-1. Suppose you buy $80 of X and $60 of Y and sell $40 of Z. What is the sensitivity of your portfolio to each of the two factors? (Do not round intermediate calculations. Round your answers to the nearest whole number.)

	Sensitivity
Factor 1
Factor 2

c-2. What is the expected risk premium? (Do not round intermediate calculations. Enter your answer as a percent rounded to the nearest whole number.)

Expected risk premium             %

d-1. Finally, suppose you buy $160 of X and $20 of Y and sell $80 of Z. What is your portfolio's sensitivity now to each of the two factors? (Do not round intermediate calculations. Round your answers to the nearest whole number.)

	Sensitivity
Factor 1
Factor 2

d-2. What is the expected risk premium? (Do not round intermediate calculations. Enter your answer as a percent rounded to the nearest whole number.)

Expected risk premium             %

Answer rating: 100% (QA)

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