Question: Problem 3 Suppose world described by 1-factor model (F), and we have 2 following securities rA = 0.050 1.2F + A rB = 0.050 +

Problem 3

Suppose world described by 1-factor model (F), and we have 2 following securities rA = 0.050 1.2F + A rB = 0.050 + 0.8F + B

a. What are the weights on each security A and B if we want to track the asset that has a loading of 0.5 on factor F?

b. What is the expected risk-free rate in this world? (Hint: construct the tracking portfolio that has zero loading on factor F)

c. What is the expected return of factor F? (Hint: construct the tracking portfolio that has a loading of 1 on factor F)

d. Is there any arbitrage opportunity if expected return on asset, that has a loading of 0.5 on factor F, is 4.50%?

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