Question

Consider the single factor APT. Portfolio A has a beta of 0.5 and an expected return of 12%. Portfolio B has a beta of 0.4 and an expected return of 13%. The risk-free rate of return is 5%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position on portfolio ________________ and a long position in portfolio ___________________

Answer 1

Answer and Explanation:

Given:

For portfolio A

Expected return of 12%

beta = 0.5

Risk premium for A = ?

For portfolio B

Expected return of 13%

beta = 0.4

Risk premium for B = ?

Risk-free rate of return = 5%

Computation:

For portfolio A

12% = 5% + (0.5 × risk premium for A)

risk premium for A = 14%

For portfolio B

13% = 5% + (0.4 × risk premium for B)

risk premium for B = 20%

short position "A"

Long position "B"