The returns on assets in an economy depend on the realization of two risk factors, denoted...
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The returns on assets in an economy depend on the realization of two risk factors, denoted by I and 1. Three well-diversified portfolios (denoted by A, B and C) are available whose returns are given by the following expressions: RA= 0.01 I +21 RB = 21 + 4/ Rc = 0.03I+I The risk factors have zero mean: E[] = 0 and E[1] = 0. (a) (8 points) Construct the factor-replicating portfolios for Factor 1, Factor 2, and the risk-free asset in this economy. (b) (5 points) Write the APT equation for this economy. (c) (5 points) A fourth well-diversified asset (denoted by D) becomes available whose return is given by: Rp = 0.12 - 21-51 Are there any arbitrage opportunities in the economy with assets A, B, C, and D? Explain. If such an arbitrage opportunity exists, explain in detail how you would implement it assuming that only assets A, B, C, and D can be traded (that is, you cannot trade the portfolios you constructed in item (a) directly). (d) (2 points) Suppose that this economy undergoes a structural change, so that now E[1] = 0.05 and E[1] = -0.01. Describe how you would carry out the analysis in items (a)-(e) in this economy. Note: you do not need to carry out the computations for this item. The returns on assets in an economy depend on the realization of two risk factors, denoted by I and 1. Three well-diversified portfolios (denoted by A, B and C) are available whose returns are given by the following expressions: RA= 0.01 I +21 RB = 21 + 4/ Rc = 0.03I+I The risk factors have zero mean: E[] = 0 and E[1] = 0. (a) (8 points) Construct the factor-replicating portfolios for Factor 1, Factor 2, and the risk-free asset in this economy. (b) (5 points) Write the APT equation for this economy. (c) (5 points) A fourth well-diversified asset (denoted by D) becomes available whose return is given by: Rp = 0.12 - 21-51 Are there any arbitrage opportunities in the economy with assets A, B, C, and D? Explain. If such an arbitrage opportunity exists, explain in detail how you would implement it assuming that only assets A, B, C, and D can be traded (that is, you cannot trade the portfolios you constructed in item (a) directly). (d) (2 points) Suppose that this economy undergoes a structural change, so that now E[1] = 0.05 and E[1] = -0.01. Describe how you would carry out the analysis in items (a)-(e) in this economy. Note: you do not need to carry out the computations for this item.
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a To construct the factorreplicating portfolios we need to find the weights for each asset that perfectly replicate the returns of the respective fact... View the full answer
Related Book For
Income Tax Fundamentals 2013
ISBN: 9781285586618
31st Edition
Authors: Gerald E. Whittenburg, Martha Altus Buller, Steven L Gill
Posted Date:
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