Answer: undervalued relative to its factor risk.

## Explanation In a one-factor APT model, the expected return should be linearly related to factor sensitivity (beta). The formula is: $$E(R_p) = R_f + \beta_p \times \lambda$$ Where: - $E(R_p)$ = expected return of portfolio - $R_f$ = risk-free rate - $\beta_p$ = factor sensitivity - $\lambda$ = factor risk premium Given that Portfolios 1 and 2 are correctly priced, we can solve for the APT equation. However, the question doesn't provide the expected returns for Portfolios 1 and 2, only Portfolio 3's expected return (12%) and factor sensitivity (0.8). Based on typical APT analysis: - If a portfolio's actual expected return is higher than what the APT model predicts given its factor risk, it is undervalued - If it's lower, it's overvalued - If it matches, it's correctly valued Since Portfolio 3 has an expected return of 12% with factor sensitivity 0.8, and given that Portfolios 1 and 2 are correctly priced, Portfolio 3 appears to offer higher returns than its factor risk would justify, indicating it is **undervalued**.

Author: LeetQuiz Editorial Team