Consider a two-factor Arbitrage Pricing Theory (APT) model, ri= a + bifi + b2.if2 + ,...

 

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Consider a two-factor Arbitrage Pricing Theory (APT) model, ri= a₁ + b₁₁ifi + b2.if2 + €, with the following information Asset i Asset 1 Asset 2 b1,b2,i 0.07 0.50 0.25 0.15 1.10 0.75 Asset 3 0.20 1,3 1.0 and the risk-free rate rp is 0.025. (a) (6 Marks) Find the value of b1,3 to preclude arbitrage opportunity. (b) (16 Marks) Explain how you would exploit an arbitrage opportunity if there is an Asset 4 with 4 = 0.13, b1,4 = 0.8, and b2,4 = 0.4. Consider a two-factor Arbitrage Pricing Theory (APT) model, ri= a₁ + b₁₁ifi + b2.if2 + €, with the following information Asset i Asset 1 Asset 2 b1,b2,i 0.07 0.50 0.25 0.15 1.10 0.75 Asset 3 0.20 1,3 1.0 and the risk-free rate rp is 0.025. (a) (6 Marks) Find the value of b1,3 to preclude arbitrage opportunity. (b) (16 Marks) Explain how you would exploit an arbitrage opportunity if there is an Asset 4 with 4 = 0.13, b1,4 = 0.8, and b2,4 = 0.4.

Answer rating: 100% (QA)

a We know that there is no arbitrage opportunity if and only if the following equation h... View the full answer