Question: 1. Consider a two Factor Model where the factors are the market returnand interest rates.(5) a. Suppose an investor constructs a well diversified risky portfolioof

1. Consider a two Factor Model where the factors are the market returnand interest rates.(5) a. Suppose an investor constructs a well diversified risky portfolioof stocks which we callPand tries to eliminate market risk via holdingPand the market portfolio. So he holdsPwith weightwand the market withweight 1w. Are returns of this combined portfolio certain as with theidentical portfolio constructed with the Index Model of Arbitrage PricingTheory?(10) b. Suppose arbitrage is impossible, then what does this imply fornon market returnsPof portfolioP?

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