$\begin{array}{|l|l|l|l|}
\hline \text { Factor } & {\left[\mathrm{E}\left(\mathrm{R}_{\mathrm{M}}\right)-\mathrm{R}_{\mathrm{F}}\right)} & \mathrm{SMB} & \mathrm{HML} \
\hline \text { Sensitivity } & \mathrm{b}_{\mathrm{i}}=1.75 & \mathrm{~s}_{\mathrm{i}}=-0.80 & \mathrm{~h}_{\mathrm{i}}=0.60 \
\hline \text { Risk premium } & 18.5 \% & 5.25 \% & 0.50 \% \
\hline
\end{array}$
-Suppose the above asset is observed in the market trading with an expected return of 28%.What strategy would you suggest to profit from this situation,assuming the Fama-French model was the correct pricing model and the risk-free rate was 8%?

A) buy the asset
B) short-sell the asset
C) buy the risk-free asset
D) sell the market portfolio

Question

$\begin{array}{|l|l|l|l|}
\hline \text { Factor } & {\left[\mathrm{E}\left(\mathrm{R}_{\mathrm{M}}\right)-\mathrm{R}_{\mathrm{F}}\right)} & \mathrm{SMB} & \mathrm{HML} \
\hline \text { Sensitivity } & \mathrm{b}_{\mathrm{i}}=1.75 & \mathrm{~s}_{\mathrm{i}}=-0.80 & \mathrm{~h}_{\mathrm{i}}=0.60 \
\hline \text { Risk premium } & 18.5 \% & 5.25 \% & 0.50 \% \
\hline
\end{array}$
-Suppose the above asset is observed in the market trading with an expected return of 28%.What strategy would you suggest to profit from this situation,assuming the Fama-French model was the correct pricing model and the risk-free rate was 8%?

A) buy the asset
B) short-sell the asset
C) buy the risk-free asset
D) sell the market portfolio

Quizplus · Accepted Answer

Using equation 9.8,which can be expressed as E(R_i)= R_f + F1F1F1S1F1F1F10_i[(R_m)- R_f] + s_iE(SMB)+ h_iE(HML),the expected return can be calculated as E(R)= 0.08 + 1.75(0.185)- 0.80(0.0525)+ 0.60(0.005)= 0.251 or 25.1%.If the asset is observed in the market to be trading with a return of 28%,then the market is out of equilibrium.The correct strategy would be to buy the asset,as it has a return that is higher than expected by the Fama-French model.That is,the price of the asset is too low (i.e.the return is too high),and hence the investor can then profit from the expected future rise in price as the market moves back into equilibrium.

-Suppose the Above Asset Is Observed in the Market Trading