Term Structure of Interest Rates

TOPIC : Term Structure of Interest Rates: Expectations Theory: Forward and SpotRates

QUESTION: Given the yield on a 7 year zero-coupon bond is 7%, yield on a 2 year strip is 5%, and forward two-year rate of 8% in year 5 (aka R5-7), what must be the forward three-year rate in year 2 (akaR2-5)?

Based on a single-factor model, assume that the risk-free rate is 6% and the expected return on a portfolio with unit sensitivity to the factor is 85% Consider a portfolio of two securities with the following characteristics:

SECURITY b(beta) SENSITIVITY PROPORTION

A 40 30

B 26 70

 

According to APT (Arbitrage Pricing Theory), what is the portfolio’s equilibrium expected return?

 

I want to understand “expected return on a portfolio with unit sensitivity to the factor vs what if its not unit sensitivity, but some other sensitivity?”

Solution: