Suppose rf = 7.25% and a well diversified portfolio P has a beta of 1.5 and an alpha of 1% when regressed against a systematic factor S. Another well diversified portfolio Q has a beta of 1.1 and an alpha of 1.67%.

Using the above information, explain if there is any arbitrage opportunity.

3 marks

If there is an arbitrage opportunity, what action would you take to capitalise on this opportunity?