Question: 2. (15 points) Assume that returns are generated with a one-factor model. Consider the following data for this one-factor economy. Assume that all of the

2. (15 points) Assume that returns are generated with a one-factor

2. (15 points) Assume that returns are generated with a one-factor model. Consider the following data for this one-factor economy. Assume that all of the portfolios are well diversified. Portfolio Factor Sensitivity 1.25 0.75 0 Expected Return 10% 7% 4% Identify whether there is any arbitrage opportunity in this economy. If there is, outline a strategy that allows you to take advantage of the arbitrage opportunity. What is the expected rate of return on this strategy? (Hint: If two portfolios have the same factor sensitivity, they must provide the same expected rate of return.)

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