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BaLLatris [955]
3 years ago
15

Consider the single factor APT. Portfolio A has a beta of 1.7 and an expected return of 19%. Portfolio B has a beta of .6 and an

expected return of 15%. The risk-free rate of return is 11%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio _________. Multiple Choice A;A A;B B;B B;A
Business
1 answer:
Paladinen [302]3 years ago
8 0

Answer: A;B

Explanation:

<em>Consider the single factor APT. Portfolio A has a beta of 1.7 and an expected return of 19%. Portfolio B has a beta of .6 and an expected return of 15%. The risk-free rate of return is 11%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio </em><em><u>A</u></em><em> and a long position in portfolio </em><em><u>B.</u></em>

You should take a short position in the Portfolio with a lower risk premium and a long position on the Portfolio with a higher risk premium.

Using the single factor APT, the formula for risk premium can be derived from;

E(r) = Rf + beta (Risk premium on factor)

<u>Portfolio A</u>

19% = 11% + 1.7 * Risk premium

1.7 * risk premium = 8%

Risk Premium = 4.7%

<u>Portfolio B</u>

15% = 11% + 0.6 * RP

0.6 * RP = 4%

RP = 6.67%

Portfolio A Risk premium is lower so it should be <u>shorted.</u>

Portfolio B Risk premium is higher so it should taken a <u>long position</u> in.

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