What are prices expected next year for each of the stocks

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Reference no: EM13924389

Suppose that three stocks (A, B, and C) and two common risk factors (1 and 2) have the following relationship:
EðRAÞ = ð1:1Þλ1 + ð0:8Þλ2 EðRBÞ = ð0:7Þλ1 + ð0:6Þλ2 EðRCÞ = ð0:3Þλ1 + ð0:4Þλ2

a. If λ1 = 4% and λ2 = 2%, what are the prices expected next year for each of the stocks? Assume that all three stocks currently sell for $30 and will not pay a dividend in the next year.

b. Suppose that you know that next year the prices for Stocks A, B, and C will actually be $31.50, $35.00, and $30.50. Create and demonstrate a riskless, arbitrage investment to take advantage of these mispriced securities. What is the profit from your investment? You may assume that you can use the proceeds from any necessary short sale.

Reference no: EM13924389

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