Part B specifically

iv. You are considering adding new financial assets to your portfolio. You observe that a mutual fund has a beta of 1.5 and an expected return of 9%. The risk-free rate is currently 1% and the market is expected to yield 5% over the next year. a) According to the CAPM: i. What is the fund's alpha? [1 mark] Should you invest in the fund? Why? (1 mark] What passive portfolio would have the same systematic risk (beta) as the fund? Clearly state the weights on the market portfolio and on the risk-free asset [2 marks] What is the return on the passive portfolio? [1 mark] What is the difference between the expected returns of the passive portfolio and the mutual fund? Why is there a difference? [2 marks] b) Now, instead of interpreting the information presented above in the context of the CAPM, interpret the beta of the mutual fund in the context of APT. That is, the beta of the portfolio is now the factor loading estimated on a single factor (market index) model. i. Is there an arbitrage opportunity that can be realized from trading the mutual fund, the market index and the risk-free asset? (1 mark) ii. To assess whether there is an arbitrage opportunity, what is the underlying assumption about the diversification and level of idiosyncratic risk of the mutual fund and the market index? [1 mark] iii. If there is an arbitrage opportunity, clearly describe the trades needed to take advantage of this opportunity and clearly state your arbitrage profit per dollar invested in the mutual fund. Complete the tables below with your answer. [6 marks) At t = 0 At t = 1 Trade Cash Flow Trade Cash Flow (Long/Short) the mutual fund (Long/Short) the market index _(Invest/Borrow) at the risk-free rate Initial Investment Profit iv. You are considering adding new financial assets to your portfolio. You observe that a mutual fund has a beta of 1.5 and an expected return of 9%. The risk-free rate is currently 1% and the market is expected to yield 5% over the next year. a) According to the CAPM: i. What is the fund's alpha? [1 mark] Should you invest in the fund? Why? (1 mark] What passive portfolio would have the same systematic risk (beta) as the fund? Clearly state the weights on the market portfolio and on the risk-free asset [2 marks] What is the return on the passive portfolio? [1 mark] What is the difference between the expected returns of the passive portfolio and the mutual fund? Why is there a difference? [2 marks] b) Now, instead of interpreting the information presented above in the context of the CAPM, interpret the beta of the mutual fund in the context of APT. That is, the beta of the portfolio is now the factor loading estimated on a single factor (market index) model. i. Is there an arbitrage opportunity that can be realized from trading the mutual fund, the market index and the risk-free asset? (1 mark) ii. To assess whether there is an arbitrage opportunity, what is the underlying assumption about the diversification and level of idiosyncratic risk of the mutual fund and the market index? [1 mark] iii. If there is an arbitrage opportunity, clearly describe the trades needed to take advantage of this opportunity and clearly state your arbitrage profit per dollar invested in the mutual fund. Complete the tables below with your answer. [6 marks) At t = 0 At t = 1 Trade Cash Flow Trade Cash Flow (Long/Short) the mutual fund (Long/Short) the market index _(Invest/Borrow) at the risk-free rate Initial Investment Profit