Sign up  |  Log in

APT - under/overvalued portfolios

Hi everyone,

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)? frown Shouldn’t D be overvalued (since its expected return is higher)? 

Thanks so much in advance! 

Master the Level II curriculum by creating custom quizzes in the SchweserPro™ QBank. Question difficulty automatically adapts to your ability level on a given topic, measuring your knowledge and keeping you motivated. Included in every Schweser Study Package.

Portfolio D has a lower sensitivity than portfolio A and a higher expected return than portfolio A.

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams

can someone explain me the logic behind the question proposed by muzzikchick? why are we building a forth portfolio? how do we determine the weight to use?

objective is to create another portfolio which has potential for either higher returns with same sensitivity or same returns with lower sensitivity. Think of sensitivity as risk.