assume that the following two index model describes returns: Ri = ai + (bi1)I1 +

Question

assume that the following two index model describes returns: Ri = ai + (bi1)I1 + (bi2)I2 + ei, simple APT model

Assume that the follwing three portfolio are observed

Portfolio expected return bi1 bi2

A 12.0 1 0.5

b 13.4 3 0.2

C 12.0 3 -0.5

1. FIND THE EQUATION OF THE PLANCE THAT MUST describe equilibrium returns

2. Referring to the results of the above question, illustrate the arbitrage opportunities that would exist if a portfolio called D with the following propoerties were observed:

Rd = 10 bD1 = 2 bD2 = 0

If (Rm - Rf) = 4, find the values for the follwoing variables that would make the expected returns consistent with equilibrium determined by the simple CAPM:

A: B1 and B2

B. bp for each of the three portfolios

C. Rf

Explanation / Answer

assume that the following two index model describes returns: Ri = ai + (bi1)I1 +

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