Market index is well-diversified portfolio

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Reference no: EM131517355

APT: Say a given market index (M) is a well-diversified portfolio and has an expected return of 15%. Deviations from this expected return (rM − 15%) can serve as the systematic factor. The T-bill rate is 3%. Say another well-diversified portfolio, call it A, has a beta of 1.5. This means:

E(rA) = 3% + 1.5 (15% − 3%) = 21%

However what if E(rA) = 25%? There is an arbitrage here. What do you do to take advantage of the arbitrage? What do you sell and buy? What is your profit per dollar invested?

Reference no: EM131517355

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