The table provides factor risk loadings and factor risk premia for a two-factor model for a particular portfolio where factor portfolio 1 tracks Inflation and factor portfolio 2, IR, tracks unexpected changes in interest rates. The risk-free rate is 3%. If a trader estimates the expected / average return of the Portfolio XYZ to be 3.5% and believes that he is correct, what is the arbitrage strategy?

Portfolio XYZ

Inflation-Factor loading of 0.5, Risk premium of 8%

IR-Factor loading of -1.5, Risk premium of 2%

1. Long XYZ, Short Inflation, Long IR, Buy Risk-Free

2. Short XYZ, Long Inflation, Long IR, Buy Risk-Free

3. Short XYZ, Short Inflation, Short IR, Buy Risk-Free

4. Short XYZ, Long Inflation, Short IR, Buy Risk-Free

5. Short XYZ, Long Inflation, Short IR, Borrow Risk-Free