first, answer this question: According to the APT, can a factor ever have negative risk premium? Explain why.

Now consider 3 factor model. Suppose the risk free rate is 1%.
Portfolio β of market factor β of size factor β of value factor Expected return
A 2 0 -0.5 5%
B 0 1.2 0.5 5%
C 2 -1.2 0 5%
D 1 1 1 ??
(a) If there is no arbitrage, what would be the expected return of portfolio D?

(b) Suppose the expected return of portfolio D is given as your answer in Question
(c). But the expected return of portfolio A has increased to 6%. Is there an arbitrage opportunity? What would be the rate of return of the arbitrage profit?
Describe the arbitrage strategy.

Answer rating: 100% (QA)

The detailed answer for the above question is provided below Answer to Question 1 No according to th... View the full answer