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Consider the single factor APT. Portfolio A has a beta of 1.2 and an expected return...

Consider the single factor APT. Portfolio A has a beta of 1.2 and an expected return of 24%. Portfolio B has a beta of .8 and an expected return of 20%. The risk-free rate of return is 7%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio _________.

A;B

A;A

B;A

B;B

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Answer #1

Solution:

According to single factor arbitrage pricing theory ,

Expected return = beta *F + Risk free rate

Portfolio A :

24% = 1.2F +7%

F= 14.17%

Portfolio B:

20% = . 8 F - 7%

F= 16.25%

Since F is higher of portfolio B so take long position in portfolio B and short position in Portfolio A

Option C is correct , B, A

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