Security expected returns and betas in 3 well-diversified portfolios
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Security expected returns and betas
Security E(R) Beta
1 10% 1.00
2 12% 1.20
3 13% 1.10
Suppose there are three well-diversified portfolios, as shown above. An arbitrage opportunity is implied in these numbers. Show mathematically how to take advantage of it.
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Solution Summary
The security expected returns and betas 3 well-diversified portfolio is determined.
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ANSWERS
From the beta and the expected return, Security or Portfolio 3 is undervalued as its expected return is 13% instead of 11% (10% x 1.10). Hence, the strategy is I will buy Security 3 (hold it long) and using the ...
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