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 isE(Ri) – Rf = [δ1 – Rf]bi1 + [δ2 – Rf]bi2, E(Ri) = 0.08 + [0.05]bi1 + [0.11]bi2. RequiredIf his portfolio currently has a sensitivity to the first factor of bi1= -0.5, what is its sensitivity to unexpected inflation?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?

Answer - Given in the question - Firm's CAPM beta = 1 Risk free rate (Rf) = 8% =0.08 CAPM risk…

Answered: Your Company, manager of the Gigantic…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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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

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

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