You are given two stocks, A and B. Stock A has a beta of 1.5, and stock
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You are given two stocks, A and B. Stock A has a beta of 1.5, and stock B has a beta of −0.25. The one-year risk-free rate is 2%. Both stocks currently trade at $10. Assume a CAPM model where the expected return on the stock market portfolio is 10% p.a. Stock A has an annual dividend yield of 1%, and stock B does not pay a dividend.
(a) What is the expected return on both stocks?
(b) What is the one-year forward price for the two stocks?
(c) Is there an arbitrage? Explain.
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