APT - under/overvalued portfolios
I hope everyone’s studies are coming along nicely…
I’m currently reading Introduction to Multifactor models (Reading 47) and I have a question regarding Example 1. It states the following:
Portfolios A, B and C have expected returns of 0.075, 0.15 and 0.07, respectively, and factor sensitivities of 0.5, 0.2 and 0.4, respectively.
Why is then portfolio D (expected return of 0.08 and with factor sensitivity of 0.45) undervalued compared to equally-weighted portfolio of A and C (same factor sensitivity of 0.45 and an expected return of 0.0725)? Shouldn’t D be overvalued (since its expected return is higher)?
Thanks so much in advance!
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