2. Two-factor APT example: (2016 ICA2 Question 1 - parts abc) Consider the following two-factor model for the returns of three well-diversified assets (i.e., with no idiosyncratic risk): "A "B rc 0.5 + 21 +212 = 0.1 - 1 + 12, = 0.4+ 11 - 12. - (a) (10 points) Compute the expected return of factor replicating portfolio 1 (FRP1), the expected return of factor replicating portfolio 2 (FRP2), and the risk-free rate. (b) (5 points) Assume we have a new asset, asset D (also with no idiosyncratic risk), with exposures plus 1 to factor 1 and minus 1 to factor 2. What is its expected return? (c) (5 points) What is the standard deviation of the return of asset D if both factors have standard deviation of 2%? 2. Two-factor APT example: (2016 ICA2 Question 1 - parts abc) Consider the following two-factor model for the returns of three well-diversified assets (i.e., with no idiosyncratic risk): "A "B rc 0.5 + 21 +212 = 0.1 - 1 + 12, = 0.4+ 11 - 12. - (a) (10 points) Compute the expected return of factor replicating portfolio 1 (FRP1), the expected return of factor replicating portfolio 2 (FRP2), and the risk-free rate. (b) (5 points) Assume we have a new asset, asset D (also with no idiosyncratic risk), with exposures plus 1 to factor 1 and minus 1 to factor 2. What is its expected return? (c) (5 points) What is the standard deviation of the return of asset D if both factors have standard deviation of 2%