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This problem explores the idea behind APT and factor models. Suppose the statistical properties of all asset returns are described by a single factor model where the market is the single factor. In particular, you can assume that there is a market portfolio and a risk-free asset that both satisfy the factor model equation in class (and in BKM).
In parts (a) through (c), consider a well-diversified portfolio A with βA = 0.4 and αA = 2.0.
a) Combine this portfolio with the market portfolio to form a zero-beta portfolio. Calculate the weightings and alpha of your zero-beta portfolio. [Hint: what are the alpha and beta of the market portfolio?]
b) Calculate the systematic, idiosyncratic and total risk of your zero-beta portfolio in (a)?
c) In light of your answers to (a) and (b), construct a zero-cost (riskless) arbitrage strategy using the zero-beta portfolio and the risk-free asset. [Recall that a zero-cost arbitrage strategy will involve buying one asset and short selling another in equal amounts]. What is the alpha of your zero-cost strategy? How much money would an investor invest in such a strategy?
Finance is about Gunns Ltd, a company in dealing with forestry products in Australia. The company has also been listed in Australian Stock Exchange. As many companies producing forestry products, even Gunns Ltd is facing various problems. Due to the ..
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