Suppose 3 risky assets whose random rates of return are governed by = 8+2f +...

 

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Suppose 3 risky assets whose random rates of return are governed by ₁ = 8+2f₁ + 3f₂ r₂ = 5+ f₁ + 2f₂ r3 = 26+ 6f₁ + 10f₂ where f₁ and f₂ are risk factors with E[ f₁ ]=E[f₂ ]=0. a) You are constructing a riskfree portfolio of these 3 risky assets, whose weights are w₁, W2 and w3. Explain why the solution of the following 3 equations give the required riskfree portfolio. [2.0] W₁ + W₂ + W3 = 1 2w₁ + W₂ + 6w3 = 0 3w₁ +2w₂ +10W3 = 0 b) After solving the above system of linear equations, we get w₁=w₂=2/3 and w3= -1/3. Suppose the expected rates of return of the 3 assets are given by μη = λο + 2λη + 3λε H₂ = A + λ₁ + 2^₂ μ3 = λο + όλη + 1032 Evaluate A0, A₁ and ₂. Explain the financial interpretation of the factor risk premia: A₁ and A₂. [3.0] Suppose 3 risky assets whose random rates of return are governed by ₁ = 8+2f₁ + 3f₂ r₂ = 5+ f₁ + 2f₂ r3 = 26+ 6f₁ + 10f₂ where f₁ and f₂ are risk factors with E[ f₁ ]=E[f₂ ]=0. a) You are constructing a riskfree portfolio of these 3 risky assets, whose weights are w₁, W2 and w3. Explain why the solution of the following 3 equations give the required riskfree portfolio. [2.0] W₁ + W₂ + W3 = 1 2w₁ + W₂ + 6w3 = 0 3w₁ +2w₂ +10W3 = 0 b) After solving the above system of linear equations, we get w₁=w₂=2/3 and w3= -1/3. Suppose the expected rates of return of the 3 assets are given by μη = λο + 2λη + 3λε H₂ = A + λ₁ + 2^₂ μ3 = λο + όλη + 1032 Evaluate A0, A₁ and ₂. Explain the financial interpretation of the factor risk premia: A₁ and A₂. [3.0]

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Solution Given return 3 risky assets whose random rates of are gov... View the full answer