Your Company, manager of the Gigantic Mutual Fund, knows that her fund currently is well diversified and that it has a CAPM beta of 1.0 The risk-free rate is 8% and the CAPM risk premium of 6.2%. She...

Your Company, manager of the Gigantic Mutual Fund, knows that her fund currently is well diversified and that it has a CAPM beta of 1.0   The risk-free rate is 8% and the CAPM risk premium of 6.2%.  She has been learning about measures of risk and knows that there are (at least) two factors: changes in industrial production index, δ₁
and unexpected inflation, δ₂
The APT equation is

E(R_i) – R_f
= [δ₁
– R_f]b_i1
+ [δ₂
– R_f]b_i2,

E(R_i) = 0.08 + [0.05]b_i1
+ [0.11]b_i2.

Required

1. If his portfolio currently has a sensitivity to the first factor of b_i1= -0.5, what is its sensitivity to unexpected inflation?

1. If she rebalances her portfolio to keep the same expected return but reduce her exposure to inflation to zero (i.e., bi₁= 0) what will its sensitivity to the first factor become?