Consider two well-diversified portfolios, A and B, that conform to a one-factor model. A key feature of the model is that there can be no arbitrage opportunities involving well-diversified portfolios. Moreover, the shock to the factor, F1,t ,  has zero mean, and idiosyncratic components of the returns on A and B are negligible. All returns are expressed in percentage points as follows:

rA,t = 14 + 1.5 F1,t  ;      rB,t = 6 + 0.5 F1,t  .

Use the absence of arbitrage opportunities involving well-diversified portfolios to calculate the risk-free rate:

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According to the onefactor model the returns on welldiversified portfolios A a... View the full answer