Question
Consider an APT world with one systematic risk: MARKET risk. Expected return for the market portfolio is 8% and risk-free rate is 3%. A stock
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Consider an APT world with one systematic risk: MARKET risk. Expected return for the market portfolio is 8% and risk-free rate is 3%. A stock analyst estimates the following characteristics for the Portfolio ABC. Assume that the analyst estimates are correct.
Portfolio E(R) Market BETA ABC 11.0% 1.5
a)What is the NO-ARBITRAGE (i.e. in equilibrium) expected return for portfolio ABC?
b) Refer to part a. Assume the market portfolio is tradable and that the analyst estimates are correct. Which of the following constitutes an arbitrage (zero-net investment) strategy (if any).
Consider an APT world with one systematic risk: MARKET risk. Expected return for the market portfolio is 8% and risk-free rate is 3%. A stock analyst estimates the following characteristics for the Portfolio ABC. Assume that the analyst estimates are correct.
| Portfolio | E(R) | Market BETA |
| ABC | 11.0% | 1.5 |
a)What is the NO-ARBITRAGE (i.e. in equilibrium) expected return for portfolio ABC?
b) Refer to part a. Assume the market portfolio is tradable and that the analyst estimates are correct. Which of the following constitutes an arbitrage (zero-net investment) strategy (if any).| Short sell ABC, buy Market portfolio, buy risk free rate | ||
| Short sell ABC, buy Market portfolio, borrow risk free rate | ||
| Short sell Market portfolio, buy ABC, buy risk free rate | ||
| Short sell Market portfolio, buy ABC, borrow risk free rate | ||
| None of the above constitutes an arbitrage strategy. |
c) Refer to a and b. Assume the trader is able to trade $1,000,000 into this strategy (i.e. able to buy or sell $1,000,000 in the arbitrage portfolio). What is the traders risk-free profit?
| $10,000 | ||
| $5,000 | ||
| $3,333 | ||
| $2,500 | ||
| None of the above |
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