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Suppose that you have access to two funds. Fund 1 has a CAPM beta of 0.4, Fund 2 has a CAPM beta of 1.9. Fund

Suppose that you have access to two funds. Fund 1 has a CAPM beta of 0.4, Fund 2 has a CAPM beta of 1.9. Fund 1 has an average return of 8.5% and Fund 2 has an average return of 10.5%. The riskless rate is 0.5% and the market risk premium is 7%. You would like to construct a Betting-against-Beta (BaB) strategy by levering up Fund 1 and delevering Fund 2 so that both have a beta of 1. Assume that you can borrow and lend at the riskless rate.

What are the expected returns of the levered Fund 1 and delevered Fund 2, respectively?

A.

18.25% and 6.47%

B.

20.50% and 5.76%

C.

10.86% and 8.00%

D.

13.75% and 7.90%

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