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Suppose that well-diversified portfolio Z is priced based on two factors. The beta for the first...

Suppose that well-diversified portfolio Z is priced based on two factors. The beta for the first factor is 1.10 and the beta for the second factor is 0.45. The expected return on the first factor is 11%. The expected return on the second factor is 17%. The risk-free rate of the return is 5.2%. Use the arbitrage pricing theory relationships, what is the expected return on portfolio Z?

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Answer #1

Market Premium for facor 1 = 11% - 5.2% = 5.8%

Market Premium for facor 2 = 17% - 5.2% = 11.8%

As per arbitrage pricing theory relationship

= Rf + (beta of factor one * Market Risk Premium factor 1) + (beta of factor one * Market Risk Premium factor 1)

= 5.2% + (1.10* 5.8% ) + (0.45* 11.8%)

= 5.2 + 6.38 + 5.31

= 16.89%

Expected Raturn = 16.89%

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