[Fin525sp09] Question on Midterm problem #3

[Adam Gehr]

You don't need a risk-free rate. All you need to do is buy and sell 
portfolios which have the same factor-sensitivities.  With three 
securities you can find a combination of two which replicate the factor 
sensitivity of the third (and it doesn't matter which you pick--you will 
get the same result). Check the expected returns to find out which to 
sell and which to buy.  If  you get the same return on all combinations 
with the same factor sensitivity, you have an equilibrium. Otherwise you 
have an arbitrage opportunity.

In this example, I'd try to find the easiest way to mix 
securities--combine the high and low sensitivity securities to match the 
sensitivity of the middle one. Then calculate expected returns.

   Adam Gehr



patrick Redmond wrote:
> Professer Gehr -
>  
> I do not understand question #3 on the sample midterm; could you 
> provide some information on this probem?
>  
> Spcifically, how to start this problem without a Risk-free rate. I 
> understand how to constitute an arbitrage, but not with the 
> information provided.
>  
> Thanks in advance for your help,
>  
> Kevin Redmond
>
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