Question

After doing some deep analysis, you find that shares of Bank of America (BAC) are over-priced and the expected return on these shares is 7.2%, while shares of Morgan Stanley (MS) are under-priced and the expected return on these shares is 12.3%.

You want to create an arbitrage portfolio (not following the book recipe) where you will buy MS and short-sell BAC. In particular, your weights will be +100% for MS, and -100% for BAC.

What is the expected return of this arbitrage portfolio?

Note here that you have an arbitrage portfolio where the sum of weights = 0%. However, a portfolio return is a portfolio return. So just compute the expected portfolio return as usual.

{Give your answer as a percentage with 1 decimals, e.g., if the answer is 0.0345224 (or 3.45224%) , enter 3.5 as your answer.}

Answer 1

What is the expected return of this arbitrage portfolio?

=100%*12.3%-100%*7.2%
=5.1000%