Question

You complete an analysis of the fund DQXQ, and you expect an excess return (return - risk free) of 14.0%. Your expectation of the excess return of the market is 15.5%, and the beta of DQXQ is 0.85. You want to create an arbitrage portfolio to take advantage of the mispricing with the following characteristics (Wp, Wmkt, Wrf, alpha).

Group of answer choices:

100% ; -85% ; borrow ; 15% ; 0.83%

-100% ; 85% ; lend ; 15% ; 0.83%

-100% ; 85% ; lend ; 15% ; 0.83%

-100% ; 85% ; lend ; 15% ; 1.50%

100% ; -85% ; borrow ; 15% ; 1.50%

Answer 1

Given

Beta = 0.85

Excess market return = 15.5%

Excess stock return = 14%

According to CAPM, the stock return must be 15*0.85 = 13.175%

Therefore the stock is giving more return than expected.

Hence, we must have a 100% long position onDQXQ stock and 85% short position on Market.

The alpha from this position will be

alpha = Excess stock return - 0.85* excess market return

= 14 - 15.5*0.85

= 14 - 13.175

= 0.825 = 0.83%

Since, we have 100% long position and 85% short positon. Thus we need to borrow rest 15% to balance our postion

Hence,

Answer is Option A

100% ; -85% ; borrow ; 15% ; 0.83%