Consider the following data on a one-factor economy. All portfolios are well-diversified. Portfolio A has a...

Consider the following data on a one-factor economy. All portfolios are well-diversified. Portfolio A has a beta of 1.0 and an expected return of 11%, while another portfolio B has a beta of 0.75 and an expected return of 8%. The risk-free rate is 2%. In this scenario, an arbitrage opportunity exists and a strategy to take advantage of it would be:

To short B and use 3/4 of the proceeds to invest in A and borrow the other ¼ at the risk-free rate.

To borrow at the risk-free rate and use the proceeds to invest in A.

To short 3/4 of A and borrow 1/4 at the risk-free rate, and use the proceeds to invest in B.

To short B and use 3/4 of the proceeds to invest in A and lend the other ¼ at the risk-free rate.

To short B and use the proceeds to invest in A.

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Detailed solution with explanation of each options.

jeff jeffy answered 1 year ago

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