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What is the portfolio arbitrage free expected return

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Reference no: EM132959988

Assume that there are two factors that price assets. Interest rate rf = 3%. You have the following information about two well-diversified arbitrage-free risky assets.

Asset 1: E(r)=12% β1=1.5 β2=2
Asset 1: E(r)=8% β1=1 β2=1

Answer the following questions:

Problem (a) Calculate the risk premium of two risk factors.

Problem (b) There is a third well-diversified portfolio with β1 = 2 and β2 = 0.5. What is this portfolio's arbitrage free expected return?

Problem (c) Suppose the forecasted return of the portfolio in the previous question is 10%. Show how you could construct an arbitrage portfolio.

Reference no: EM132959988

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