Suppose in a single factor APT model, portfolio A has a beta of 1.3 and expected returns of 21%. Portfolio B has a beta of 0.7 and returns of 17%. The risk free rate is 8%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio _________ and a long position in _____.
A) A, A
B) A, B
C) B, A
D) B, B

Question

Suppose in a single factor APT model, portfolio A has a beta of 1.3 and expected returns of 21%.  Portfolio B has a beta of 0.7 and returns of 17%.  The risk free rate is 8%.  If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio _________ and a long position in _____.
A) A, A
B) A, B
C) B, A
D) B, B

Quizplus · Accepted Answer

Portfolio A has a higher beta than portfolio B, which means it is more sensitive to changes in the market. Therefore, it is expected to have higher returns than portfolio B. However, the expected returns of portfolio A are lower than those of portfolio B. This presents an arbitrage opportunity, where you can take a short position in portfolio A and a long position in portfolio B to profit from the difference in expected returns.

Suppose in a Single Factor APT Model, Portfolio a Has