c). During the meeting, Harry showed strong interests in BRIGHTON and requested Mike to design an arbitrage strategy, which could profit from the positive alpha of BRIGHTON. The strategy should only involve BRIGHTON, the market portfolio (Mkt), and the risk-free asset (RF). Describe how to set up the strategy. What is the weight on the risk-free asset in the strategy?

Question 5 (14 marks) Mike works as an investment analyst in OBECO, a giant funds of funds company with over $2 trillion assets under management (AUM). OBECO diversifies its $2 trillion AUM among a number of professional managers actively managed funds. Thus, the overall holdings of OBECO resembles a well-diversified portfolio with the same risk-return profile as that of the market portfolio. Mike is preparing for a meeting with his directors, Jennifer and Harry, to discuss whether their firm (OBECO) should allocate $20 million to the two actively managed funds, BRIGHTON and FULLERTON, respectively. Both funds are not in the current holdings of OBECO. To evaluate their fund performance, Mike gathered the monthly data over the past five years, and has prepared the following descriptive statistics for the two funds, the market portfolio (denoted as Mkt), and the risk-free asset (denoted as RF). See below: Table of descriptive statistics of monthly returns BRIGHTON FULLERTON Mkt RF Mean Return (in %) 1.70 1.30 1.30 0.10 Standard Deviation of Return (in %) 2.90 3.00 2.00 0 Mike believes that the excess returns of both funds are influenced by changes in excess returns of the market portfolio (denoted as Mkt-RF), so he uses the single-factor model by regressing the excess return of the fund on that of the market. He obtains the following regression output for the two funds: Table of the regression output for the fund BRIGHTON: Coefficients Standard Error t-Statistics p-value Intercept 0.2080 0.0701 2.9672 0.0030 Mkt-RF 1.1600 0.3386 3.4259 0.0006 Table of the regression output for the fund FULLERTON: Coefficients Standard Error t-Statistics p-value Intercept 0.4800 0.2969 1.6167 0.1059 Mkt-RF 0.6000 0.1386 4.3290 0.0000 c). During the meeting, Harry showed strong interests in BRIGHTON and requested Mike to design an arbitrage strategy, which could profit from the positive alpha of BRIGHTON. The strategy should only involve BRIGHTON, the market portfolio (Mkt), and the risk-free asset (RF). Describe how to set up the strategy. What is the weight on the risk-free asset in the strategy? Question 5 (14 marks) Mike works as an investment analyst in OBECO, a giant funds of funds company with over $2 trillion assets under management (AUM). OBECO diversifies its $2 trillion AUM among a number of professional managers actively managed funds. Thus, the overall holdings of OBECO resembles a well-diversified portfolio with the same risk-return profile as that of the market portfolio. Mike is preparing for a meeting with his directors, Jennifer and Harry, to discuss whether their firm (OBECO) should allocate $20 million to the two actively managed funds, BRIGHTON and FULLERTON, respectively. Both funds are not in the current holdings of OBECO. To evaluate their fund performance, Mike gathered the monthly data over the past five years, and has prepared the following descriptive statistics for the two funds, the market portfolio (denoted as Mkt), and the risk-free asset (denoted as RF). See below: Table of descriptive statistics of monthly returns BRIGHTON FULLERTON Mkt RF Mean Return (in %) 1.70 1.30 1.30 0.10 Standard Deviation of Return (in %) 2.90 3.00 2.00 0 Mike believes that the excess returns of both funds are influenced by changes in excess returns of the market portfolio (denoted as Mkt-RF), so he uses the single-factor model by regressing the excess return of the fund on that of the market. He obtains the following regression output for the two funds: Table of the regression output for the fund BRIGHTON: Coefficients Standard Error t-Statistics p-value Intercept 0.2080 0.0701 2.9672 0.0030 Mkt-RF 1.1600 0.3386 3.4259 0.0006 Table of the regression output for the fund FULLERTON: Coefficients Standard Error t-Statistics p-value Intercept 0.4800 0.2969 1.6167 0.1059 Mkt-RF 0.6000 0.1386 4.3290 0.0000 c). During the meeting, Harry showed strong interests in BRIGHTON and requested Mike to design an arbitrage strategy, which could profit from the positive alpha of BRIGHTON. The strategy should only involve BRIGHTON, the market portfolio (Mkt), and the risk-free asset (RF). Describe how to set up the strategy. What is the weight on the risk-free asset in the strategy