Suppose in a single factor APT model, portfolio A has a beta of 0.2 and an expected return of 13%. Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate is 10%. If an investor wanted to take advantage of an arbitrage opportunity, he or she would take a short position in portfolio _____ and a long position in portfolio _____.
A) B, A
B) A, B
C) A, A
D) B, B

Question

Suppose in a single factor APT model,  portfolio A has a beta of 0.2 and an expected return of 13%.  Portfolio B has a beta of 0.4 and an expected return of 15%.  The risk-free rate is 10%.  If an investor wanted to take advantage of an arbitrage opportunity, he or she would take a short position in portfolio _____ and a long position in portfolio  _____.
A) B, A
B) A, B
C) A, A
D) B, B

Quizplus · Accepted Answer

To take advantage of an arbitrage opportunity, an investor would take a short position in the overpriced portfolio and a long position in the underpriced portfolio. Therefore, the correct choice is A where the investor would take a short position in portfolio B (overpriced) and a long position in portfolio A (underpriced).

Suppose in a Single Factor APT Model, Portfolio a Has