Ms. Bessie, manager of Everchanging Mutual
Fund, know he 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 [E(Rm –
Rf] is 6.2%. She has recently become aware of
APT measures of risk and knows that there are
(at least) two factors: Industrial Production κ1
and inflation κ2. The equation for APT is
E(Ri) – Rf = [k1-Rf] bi1 + [k2-Rf] bi2
E(Ri) = 0.08 + [0.05]bi1+ [.11]bi2
a) If the portfolio’s current sensitivity to the
Industrial production factor is bp1 is -.5 what is
the sensitivity to the inflation factor.
b) If she rebalances her portfolio to keep the
same expected return but reduce exposure to
inflation to 0 (i.e bp2 = 0) what will the
sensitivity to the industrial production factor.
Sensitivity to the inflation factor=-0.79(Rounded to two decimals)
Exposure to Inflation =0
Sensitivity to Industrial production factor=1.24
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