A different analyst uses a two-factor APT model to evaluate expected returns and risk. The risk premiums
Question:
A different analyst uses a two-factor APT model to evaluate expected returns and risk. The risk premiums on the factor 1 and factor 2 portfolios are 4.95% and 2.75%, respectively, while the risk-free rate of return remains at 3.25%. According to this APT analyst, your portfolio formed has a beta on factor 1 of 5.50 and a beta on factor 2 of 3.50.
A) According to APT, what is the expected return on your portfolio if no arbitrage opportunities exist? Enter your answer rounded to two decimal places.
B) Now assume that your forecasting model accurately projects the expected return of Stocks A and B and therefore your portfolio, and that the APT model describes the fair rate of return for your portfolio.
What is your best estimate of the alpha of your portfolio when using the APT model to determine a fair level of expected return?
Expert Answer:
A Using the twofactor APT model Expected return riskfree rate beta1 risk premiu... View the full answer
