Arbitrage profits from this trading strategy

Reference no: EM133491968

Case: Consider a stock market trader who relies on the CAPM to generate their trading ideas. Their trading approach is to buy stocks that are undervalued when compared to the CAPM-implied return and short-sell stocks that are overvalued compared to the CAPM-implied return. Currently, the risk-free rate is 4% and the expected return on the market is 10%. The trader has estimated that BHP has a beta of 1.2 and an expected return 10.5%. The trader expects CSL to have a beta of 0.8 and an expected return of 9.5%.

Question 1: Which stock would the trader buy, and which would they sell, based on their trading strategy.

Question 2: Discuss three factors that could limit the arbitrage profits from this trading strategy?

Reference no: EM133491968

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