Question: Problem 18. (20 points) There are two factors in the economy WlllCl'l describe the returns of stocks. The two factors l'1a-'e zero means and the

Problem 18. (20 points) There are two factors in the economy $WlllCl'l describe the returns of stocks. The two factors l'1a\\-'e zero means$

and the same variances of 0.02 and 0.02. respectively. The factors are

also 111'1correlated with each other. Consider the following; factor model for the

Problem 18. (20 points) There are two factors in the economy WlllCl'l describe the returns of stocks. The two factors l'1a\\-'e zero means and the same variances of 0.02 and 0.02. respectively. The factors are also 111'1correlated with each other. Consider the following; factor model for the returns of three WCllCllVOl'SlCd assets (i.e., no idiosyncratic risk): R1 : 0.09 F1 i 2F2 F31 1332 = 0.08 21?1 : F2 92 R3 2'? + F1 + 21:2 + 93 (a) (10 points) If the noarbitragc riskfree rate is 1%, What is the expected return on asset 3'? (b) (10 points) Given that the factors have the same variance and are 1.111eorrelated with each other, which of the three assets has the highest Sharpe ratio? \"Thy

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