Question: Assume a two-factor APT world where the systematic risks are INFLATION risk and CRUDE risk. The risk-free rate r f is 3%. Assume there exists

Assume a two-factor APT world where the systematic risks are INFLATION risk and CRUDE risk. The risk-free rate r_f is 3%. Assume there exists INFLATION and CRUDE factor portfolios that are tradeable. ( All information given in this question,beta for factor loading provided below)

Portfolio ABC Factor Loading Risk Factor Portfolio Risk Premium

_INFLATION 1.2 INFLATION 3.2%

_CRUDE 0.4 CRUDE 6.5%

a)Use the information in the table above to compute the NO-ARBITRAGE expected return for Portfolio ABC.

b)A trader estimates the expected return of Portfolio ABC to be 8.5%. Assume the factor loadings reported in the table are correct. According to the trader, what is the alpha of Portfolio ABC?

c) Refer to part a and b . Assume the trader in part b is correct. Construct a trading strategy that generates an arbitrage profit.

		Buy ABC, short INFLATION risk factor portfolio, borrow at the risk-free
		Buy ABC, short INFLATION risk factor portfolio, short CRUDE risk factor portfolio, and buy the risk-free asset
		Short ABC, short INSFLATION risk factor portfolio, short CRUDE risk factor portfolio, and borrow at the risk-free rate
		Short ABC, buy INFLATION risk factor portfolio, buy CRUDE risk factor portfolio, and borrow the risk-free asset
		None of the above strategies generate an arbitrage profit

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Portfolio ABC	Factor Loading	Risk Factor Portfolio	Risk Premium
_INFLATION	1.2	INFLATION	3.2%
_CRUDE	0.4	CRUDE	6.5%