Question: The table below provides factor risk loadings and factor risk premium for a two-factor model for a particular portfolio where factor portfolio 1 tracks GDP

The table below provides factor risk loadings and factor risk premium for a two-factor model for a particular portfolio where factor portfolio 1 tracks GDP and factor portfolio 2, IR, tracks unexpected changes in interest rates. The risk-free rate r_fis 3%.

Portfolio ABC	Factor Loading	Risk Factor Portfolio	Risk Premium
_GDP	0.9	GDP	7%
_IR	-1.3	IR	3%

a)Compute the expected excess return of the portfolio.

b)A trader estimates the average return of the asset to be 3.0% and believes that he is correct. According to the trader, what is the alpha of the asset?

c)Describe an arbitrage strategy based on part a and b

		Buy the asset, short GDP, buy IR, borrow risk-free
		Buy the asset, short GDP, borrow risk-free
		Short the asset, buy GDP, buy IR, borrow risk-free
		Short the asset, buy GDP, short IR, lend risk-free
		None of the above

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