Assuming a one-factor model of the form:
ri = 4% + btF + et
consider three well-diversified portfolios (zero nonfactor risk).The expected value of the factor is 8%.

Is one of the portfolio's expected return not in line with the factor model relationship? Which one? Can you construct a self-financing combination of the other two portfolios that has the same factor sensitivity as the "out-of-line" portfolio? What is the expected return of that combination? What action would you expect investors to take regarding these three portfolios?

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FactorExpected Return Portfolio Sensitivity 0.80 1.00 1.20 10.4% 10.0 13.6