Question

Consider the single factor APT. Portfolio A has a beta of 0.55 and an expected return of 11%. Portfolio B has a beta of 0.90 and an expected return of 16%. The risk-free rate of return is 3%. Is there an arbitrage opportunity? If so, how would you take advantage of it?

Answer #1

Yes there is an arbitrage opportunity,

Expected rate of return= risk free rate+(beta X market risk premium)

A= 11= 3+.55 market risk premium

Market risk premium=( 8/.55)= 14.54

B = 16= 3+.90 market risk premium

Market risk premium= (13/.9)= 14.44

so we can see that there is a difference in the market risk premium and we can take the advantage of the difference in the market risk premium between the two staff and enter into the orbital and we can make a return of .10 %(14.54-14.44)

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-1.1
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