Consider the following simplified APT model: Factor Expected Risk Premium Market 6.4% Interest Rate -0.6% Yield Spread 5.1% Factor Risk Exposures Market Interest Rate Yield Spread Stock Stock (b1)...

Consider the following simplified APT model:



Factor                                                  Expected Risk Premium

Market                                                6.4%

Interest Rate                                       -0.6%

Yield Spread                                        5.1%






                                                       Factor Risk Exposures

Market               Interest Rate             Yield Spread Stock                          Stock (b1)                  (b2)                             (b3)

P                                    1.0                           -2.0                             -0.2

P2                                  1.2                            0                                 0.3

P3                                  0.3                            0.5                              1.0



a) Calculate the expected return for the above stocks. Assume risk free rate is 5%. Consider a portfolio with equal investments in stocks P, P2 , and P3 b) What are the factor risk exposures for the portfolio?

c) What is the portfolio’s expected return?