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What is the equation representing the three-factor

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Reference no: EM133071937

Suppose the three most important sources of risk for the German economy are the growth rate in the Gross Domestic Product (GDP), the inflation rate (INF) and the growth rate in the oil price (OIL). News about these macroeconomic factors are denoted by FGDP, FINF, and FOIL, respectively. The risk-free Treasury bill rate is 3%. Consider the following three well-diversified portfolios.

Portfolio Expected Return Beta on FGDP Beta on FINF Beta on FOIL

X 11.40% 1.20 0.40 -0.20

Y 18.80% -0.10 0.30 1.50

Z 15.00% 0.50 0.50 0.60

1. What is the equation representing the three-factor security market line for this economy?

2. Suppose that a well-diversified portfolio W has an expected return of 11%. It is fairly priced based on the asset pricing model you found in Question 1 and has no exposures to GDP and INF shocks. What is portfolio W's return sensitivity to OIL news?

3. Suppose you observe -2%, 3%, and 5% unanticipated changes in GDP, INF, and OIL, respectively. What are your revised estimates of the expected returns on portfolios W, X, Y, and Z?

Reference no: EM133071937

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