Here we price securities assuming that the APT holds, while the risk-free rate is rf = 6%.

Asset 1 2 E(r)

A 1.2 0.8 19.6%

B 0.8 1.2 18.4%

C 1 1 ??

D 1.1 1.5 ??

1. Price securities C and D (estimate the expected return).

2. What is the arbitrage profit you can make, if E(rC) is 20% and how?

3. Create a portfolio using securities A, B and the risk-free asset that replicates the factor exposures of asset C.

4. Create a portfolio using securities A, C and the risk-free asset that replicates the factor exposures of asset D