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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! 

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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.

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