first, answer this question: According to the APT, can a factor ever have negative risk premium? Explain why.

Now consider 3 factor model. Suppose the risk free rate is 1%. Portfolio of market factor of size factor of value factor Expected return A 2 0 -0.5 5% B 0 1.2 0.5 5% C 2 -1.2 0 5% D 1 1 1 ?? (a) If there is no arbitrage, what would be the expected return of portfolio D?

(b) Suppose the expected return of portfolio D is given as your answer in Question (a). But the expected return of portfolio A has increased to 6%. Is there an arbitrage opportunity? What would be the rate of return of the arbitrage profit? Describe the arbitrage strategy.